Predatory Pricing - Microsoft's Modus Operandi

NEWS ALERT: Microsoft wins antitrust trial! Why? Because, in spite of its settlement, Microsoft doesn't have to lower prices. The raison d'être for being a monopoly is to be able to set prices to maximize profits at the expense of the consumer. Indeed, this is the very definition of monopoly. Microsoft suppressed competition so that it didn't have to compete on price. A monopoly has no other purpose for stifling competition! The Department of Justice's myopic focus on competition is because this trial was brought about by the behest of Microsoft's competitors, and not by consumers, who are being gouged by the billions! Because Microsoft's monopoly is firmly established, the concessions it made in its settlement will have little effect on the company or the competition, and will do nothing to lower Microsoft's truly exorbitant prices.

Microsoft has a simple strategy for earning great profits. The software business is a natural monopoly business because average total costs continually decline with increased output. Therefore, if Microsoft could find a way to eliminate competition without having to compete on price, then profits would increase dramatically as Microsoft sold more software. Microsoft has succeeded. Ironically, the main method that Microsoft has used to stifle competition is predatory pricing—distributing its products at no apparent cost to the consumer, primarily by original equipment manufacturer (OEM) distribution, so that its software becomes a standard, which would then allow Microsoft to charge that price which yields maximum profits at the expense of the consumer.

The greatest harm to consumers by the Microsoft monopoly is price gouging—an issue not even being addressed by the current antitrust trial. Nor do any of the remedies in the Final Judgment directly address this issue. Imagine being able to buy a full legal copy of Microsoft Office Premium Edition for less than $30 (Current retail price: $799; Upgrade price: $459)! Or Windows 2000 for even less!

NEWS ALERT! According to a Yahoo news article (5/8/2001) that is no longer online, Microsoft wants to do away with perpetual use licenses, and force licensees to pay Microsoft perpetually! When you buy any Microsoft product, you don't actually own the product, you license it. Microsoft is going to change the terms of that license so that you have to pay it FOR AS LONG AS YOU USE THEIR SOFTWARE! Although Microsoft is initially making the license change for businesses, they will almost certainly try to extend it to consumers, if the new model works for businesses. It's like going to Sears to buy tools, and instead of owning them, Sears gives you the right to use them for an annual fee. Imagine paying an annual fee for everything you own. If this isn't the best evidence that Microsoft is a monopoly, I don't know what is. Only a monopoly could even contemplate getting away with such an outrageous scheme!

The best evidence that Microsoft is a monopoly and insulated from price competition is its huge profits. As Microsoft's installed base expands, its average cost per unit of software is dropping dramatically, but it doesn't want to pass the savings on to the customer, as they would have had to if they had true competition, which they minimized primarily by OEM distribution of their software, which continues to this day! Herein lies Microsoft's true "success"—fleecing the customer!

Once Netscape is sufficiently minimized, Microsoft will be the standard setter on the Internet, not the W3C. Then Microsoft will be able to eliminate any browser competition whatsoever by developing proprietary technologies that only work in Internet Explorer!

Pirates serve a public interest both to purchasers of legitimate Microsoft software and to society in general!

If Microsoft wanted to, it could stop most piracy of its software, wherever it may be, regardless of the laws of the countries of the world, regardless of whether it even knows about the piracy—all without filing a single lawsuit or using copy-protection schemes!

As a monopolist, Microsoft provides as little value as possible to each upgrade, to extend the upgrade cycle as long as possible for greater profits. Maybe this explains the lack of innovation in a company with so many advantages as a monopoly and with so many billions of dollars to invest for research and development! Thus, ironically, Microsoft's best strategy is NOT to innovate!

Microsoft can raise prices without raising prices!

Microsoft wants to sell software as a service to continue the upgrade cycle indefinitely (original source: http://yahoofin.cnet.com/news/0-1003-200-2128557.html, no longer available). The problem with paying a subscription for software is that you don't know what you are getting for your money, or whether you even need or want the upgrade. Of course, if Microsoft switches to the recurrent-fee license model, which is apparently their intention, it won't matter whether you're getting your money's worth, or if you need the upgrade—you simply won't have any choice. You will have to pay Microsoft for as long as you use their software, even if they don't add any more value to it. According to this CNET story (2/23/2001, original source: http://yahoofin.cnet.com/news/0-1005-200-4928051.html?tag=rltdnws, no longer available), Microsoft's Internet Explorer now commands 87% of the market, Netscape 12%, and all other browsers combined, 1%.

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Introduction

Solve this problem: A monk decided to go to a temple at the top of a mountain. He started plodding up the steep path early in the morning. Because of the steepness, he needed to stop and rest several times, so it took him 8 hours to reach the top. He rested in the temple overnight, then started back down at the same time in the morning, taking the same pathway. Because he was walking downhill, he could walk much faster and needed no rest, getting to the bottom in only 3 hours. Prove that there is a point on the pathway, which the monk reached at the same time on both days.

Many people would have difficulty solving this problem. The solution lies in the ability to look at it in a certain way, and when one does, the solution becomes obvious. The debate about whether Microsoft is a monopoly or not is similar. Both sides seem to have good arguments, but when you look at Microsoft from a fundamental perspective—by understanding a few basic economic principles—it becomes obvious that Microsoft is a monopoly, and furthermore, it is indisputable. It becomes transparent what Microsoft is doing and why it is doing it, and all of the arguments purporting to support Microsoft are easily refuted.

There has been much debate recently, spurred by the antitrust trial brought against Microsoft by the Department of Justice (DOJ), about whether Microsoft is a monopoly, and if it is a monopoly, is it nonetheless good for the public. It is apparent from reading the pros and cons about Microsoft that many people don't understand what a monopoly is (although they think they do), and why it isn't good for the public. While Judge Jackson has done an excellent job of showing Microsoft as a monopoly (U.S. v. Microsoft: Court's Findings of Fact), this trial focused mainly on the tying of Internet Explorer (IE), Microsoft's web browser, with Microsoft's Windows operating systems, where it has a de facto monopoly in PC operating systems. Because Microsoft is not explicitly charging for IE, this is also an example of predatory pricing—pricing products below their cost of development and distribution to drive competitors out of the market. Predatory pricing is the major tool that Microsoft uses to establish its various monopolies. Although Microsoft's free distribution of IE is a classic case of predatory pricing, Microsoft has attempted to muddy the waters in the current DOJ trial by claiming that IE is part of the operating system. Furthermore, Microsoft claims in its Proposed Conclusions of Law (original source: http://www.microsoft.com/presspass/trial/p-col/col.asp, no longer available) that even if IE were a separate product, predatory pricing as a cause of action must fail because Microsoft never recouped any of IE's costs of marketing and development, and never will, and therefore fails to establish the second requirement of predatory pricing as a cause of action, that of recoupment of costs, clarified by the Supreme Court in BROOKE GROUP LTD. v. BROWN & WILLIAMSON TOBACCO CORP. These arguments are specious, as the rest of this article will show. Predatory pricing has been a Microsoft tradition since its early days, with no better illustration of its modus operandi than its greatest success story and most profitable product, a product that is NOT being covered by the antitrust trial and where Microsoft has definitely recouped its costs—Microsoft Office.

Monopoly Defined

There are various definitions of monopoly. Often, a monopoly is described as a single seller of goods or services that have no close substitutes and for which there are high barriers to entry. However, this definition does not accurately characterize a monopoly, because it is possible for a monopoly to exist, even if none of the above criteria is true. Such is the case for Microsoft.

Consider Microsoft's monopoly of the office-suite market with its product, Microsoft Office. Microsoft isn't the only seller of office suites. Corel WordPerfect Office, Lotus SmartSuite, and StarOffice are comparable products and close substitutes. Moreover, even though it would cost a lot of money for a new company to create another office suite to compete with the established players, thus creating a high barrier to entry, this is not what makes Microsoft a monopoly. What makes Microsoft a monopoly is a high barrier to competition. In economic terms, a monopoly is often described as a price setter. Certainly, Microsoft sets prices without regard to competitor's prices, which is why MS Office is the most expensive office suite. But Microsoft is also a value setter. Constrained by market expectations, Microsoft doesn't raise prices. It simply maintains historically high prices while giving the least value for the money.

Artificial and Natural Barriers to Competition in the Software Business

A monopoly cannot exist without strong barriers to competition. Obviously, the traditional factors, such as a high barrier to entry, or lack of close substitutes can help establish a monopoly, but there are strong natural barriers to competition in the software industry that are unique and exist only if one company predominates. The more it predominates, the greater the natural barriers. Thus, the key to establishing a monopoly is by gaining predominance as quickly as possible. Once a monopoly is achieved, the natural barriers to competition will maintain the monopoly. The primary and most effective method that Microsoft has used to establish predominance is predatory pricing—either giving the software away for free, as with Internet Explorer, or distributing it through OEMs, as it has done for years with Microsoft Office, and still continues to do so. (Look at the back cover of virtually any issue of PC Magazine. Dell Computer regularly advertises there, and almost every system they sell is sold with some version of Microsoft Office or Works.)

However, to establish a monopoly more quickly, Microsoft also created artificial barriers to competition.

Artificial Barriers

Microsoft gave OEMs an incentive to distribute Microsoft products with every computer sold.

Per-Processor License — For years, Microsoft stipulated that OEMs would have to pay a per-processor price for Windows—the OEM would have to pay Microsoft for each computer sold, whether that computer had Microsoft’s operating system or not. Thus, an OEM had a strong disincentive to sell any other operating system, regardless of how little the competing products cost, or how great their quality. Although Microsoft was forced to stop charging a per-processor fee by the DOJ, it was too late. Microsoft’s market share had increased tremendously, allowing the natural barriers to competition to continue stifling Microsoft's competitors.

Price Discrimination — Microsoft gave the best prices for Windows to those OEMs that also sold or distributed Microsoft’s other products. Thus, OEMs could lower their own costs by distributing Microsoft's other products, which, in turn, foreclosed competition in other areas.

Natural Barriers

With the greatly increased market shared garnered by Microsoft through OEM distribution of its software, the natural barriers to competition increased greatly.

Network Effect — As a company’s software becomes widely distributed, it draws more third-party support. There will be more schools, businesses, websites, and private tutors using, teaching, and supporting the software, and there will be more books and magazine articles. For instance, the computer section of just about any bookstore has far more titles on Microsoft software than that of any other company. Third-party support helps to advertise Microsoft’s products, and increasingly, people and businesses see it as a standard, and a safer investment in both time and money. Buying non-Microsoft software would be seen as increasingly risky, for as more people buy the standard and fewer people buy competing products, then one questions how long the other companies will have enough money to continue improving and supporting their product, or even if they will be around much longer. For as a company’s sales diminish, so does the network effect, causing a downward spiral of the company’s sales and prospects. WordPerfect Office is a good example. In the early 1990’s, there were numerous books on Quattro Pro, the spreadsheet in WordPerfect Office. Now, it would be hard to find a single book about it, even in a large bookstore. The best one could find is a few chapters in one of the few remaining books on WordPerfect Office.

Investment Effect — When people and businesses invest time and money for particular software, they will continue to upgrade to the same software in order minimize lost productive time. Learning the new features of an upgrade will be quicker, easier, and less stressful than learning entirely new software, and it helps maintain compatibility with old files. Because Microsoft has been distributing its software with new computers for years, most people and businesses already have a large investment in Microsoft software, and thus, are effectively locked to the company.

The software business is a natural monopoly business. Although it is generally expensive to produce software, it is very cheap to make copies. The marginal cost of software is virtually zero, so average total costs decline with each copy sold. Once a company establishes a lead, it will become more difficult for competitors to compete against the leader with lower prices, since their own costs have to be recouped with fewer sales. The fewer the sales, the greater the price competitors will have to charge to remain profitable. However, because the network and investment effect for Microsoft products is already great, Microsoft doesn't need to lower prices to maintain its monopoly, which is why it doesn't.

These natural barriers will insure that Microsoft will be the predominant software company for years to come, no matter what the courts finally do about Microsoft!

Predatory Pricing

Creating or Maintaining a Monopoly:

While it is not illegal to have a monopoly position in a market, the antitrust laws make it unlawful to maintain or attempt to create a monopoly through tactics that either unreasonably exclude firms from the market or significantly impair their ability to compete.

Per Se Violation:Rule of Reason Analysis:

Per se means in and of itself. A per se violation is considered inherently illegal, and has no legitimate justification for it.

Business practices that may have antitrust implications and legitimate business justifications are not illegal per se, so they must be examined under a rule of reason analysis, using principles and criteria developed by the courts and antitrust agencies. A practice is illegal if it restricts competition in some significant way without any overriding business justification. Thus, while a monopoly is not illegal per se, a rule of reason analysis may find that the methods used to achieve and maintain it had no other business objective other than monopolizing a market, and this is illegal.

Sherman Antitrust Act:

Section 1 of the Sherman Act outlaws "every contract, combination, or conspiracy, in restraint of trade," but long ago, the Supreme Court has ruled that the Sherman Act prohibits only those contracts or agreements that restrain trade without a legitimate business justification.

Section 2 makes it unlawful for a company to "monopolize, or attempt to monopolize," trade or commerce. Business methods whose main purpose is to establish a monopoly, and that have no legitimate business justification, are illegal. Predatory pricing is actionable under this section.

Stake In The Ground:

A somewhat grandiose, even gory core marketing term, signifying the area or market segment where Microsoft plans to place its hoped-for monopoly. At the proper juncture, the stake is removed and buried in the heart of the competition. -- From the Microsoft Lexicon

Price Elasticity

The correlation of price and demand for a given product, quantified by dividing the percent change in demand by the percent change in price. Higher prices lower demand.

The idea of predatory pricing is simple enough. Lower prices below cost to drive out competitors, then raise prices for maximum profits. When true competition exists, a company can only raise prices slightly above its costs, because competition prevents the company from raising prices further. But a monopoly can raise prices much higher, because it doesn't have to consider the competition. This isn't the highest price it could charge, because a monopoly has control only on the supply, not the demand for a product, and thus is subject to price elasticity just as other companies are. The higher the price, the lower the demand. Another factor that limits the price that can be charged for software is illegal copying. The higher the price of software, the greater the distribution of illegal copies. So a price exists at which profits are maximized. A higher price will reduce the number of copies sold that will lower profits more than the higher price will increase it, and a lower price will reduce profits more than the greater number of copies sold will increase it.

Let's look at a simplified, abstract example. A company sells widgets and it costs $20 to make a widget. The company has no competitors, so it's a monopoly. The company measured the price elasticity of widgets, by varying its price, and found the following demand schedule:

PriceofWidget

NumberSold

TotalProfits

$30

10

$100

$40

6

$120

$60

4

$160

$80

2

$120

$100

1

$80

Without competition, the monopoly can freely set its price at $60, even though it costs the company only $20 to produce a widget. But what if competitors moved in, and starting charging $30 for a widget. Obviously the company would no longer be able to charge $60 a widget; otherwise, the company's customers will buy from its competitors at the lower price. A monopoly charges a price significantly higher than its costs, and higher than what it could if the company had true competition.

If the company responded to its new competition by lowering the price of a widget to $10 until it bankrupted or drove out its competitors, then resumed charging $60 for a widget, this would be an example of predatory pricing. Of course, for predatory pricing to work, there must be a high barrier to entry; otherwise new competition will move in as soon as the monopolist raised prices.

"To our surprise, $89 did not seem too high to them. After seeing the feature list and the demo and remembering what they paid for Win 95, they thought, yes, they would shell out another $89 to upgrade to Memphis. Some said they would buy it for $69. But in any case they saw more value in the product than the OEM and fringe users in our previous focus groups. So there is hope for a higher price point than originally suggested. Our original thought was $49 for Win 95 users, and $89 for 3.x users."

This plainly suggests that Microsoft would have made a nice profit at $49, but because people were willing to pay more and had no competition to compare it to, and because Microsoft didn't have any competition to worry about, Microsoft decided to charge the higher, profit-maximizing price of $109, even higher than suggested in this memo!

Predatory Pricing of Microsoft Office Through OEM Distribution

Microsoft Office is, by far, the dominant office suite today. Microsoft Office was and is a good office suite, but so is WordPerfect Office and SmartSuite. Plenty of reviews list the various office suites as editor's choices through the years, which underscores their comparability. In fact, even listing an office suite as an editor's choice isn't really too informative. Since each suite has its strengths and weaknesses, it would be better just to list those strengths and weaknesses so that people could choose based on what they do. For instance, WordPerfect has a vastly superior mail merge than Microsoft Word, even today. Where Microsoft did lead is that it came out with an office suite for Windows earlier than the others, and had better integration. Of course, this is because Microsoft developed Windows and OLE, a Windows technology that allows programs to communicate better. The other predominate advantage was that Microsoft had a better and more consistent macro language, based on BASIC, the computer programming language. Nonetheless, it can't be denied that Microsoft Office's rapid and widespread popularity resulted primarily from distribution by OEMs, such as Compaq and Dell Computer. And this same distribution curtailed sales of WordPerfect Office and SmartSuite. Here's an interesting quote: "...a huge quantity of new PCs are shipped with a version of Microsoft Office already installed on the hard disk." More about this later.) (Quote was based on a review of the Office suites in http://www.zdnet.co.uk/pcdir/content/2000/05/software/gr_office_suites/, which is no longer available).

"A year ago, a Microsoft programmer working on the then-unreleased OLE 2.0 told me it would be a year before Microsoft's applications programmers understood it, and even longer before other companies did."

Microsoft's main advantage in software development was developing and using the application programming interfaces (APIs). Thus, the Microsoft Office programmers could use OLE 2.0, for instance, before anybody else. OLE 2.0 was particularly important because it allowed much better integration of different software packages, an important selling point for office suites that consisted of several different individual applications.

"WordPerfect is the clear winner for both overall satisfaction and technical support..."

This is a quote from a readers' survey on word processors, the most popular type of application, that included Word, WordPerfect, and several other word processors that are now defunct. Even today, WordPerfect is better than Word in many ways, despite Microsoft's advantages as a monopoly and the operating system developer.

"A reader survey of user satisfaction with various categories of software packages finds that Lotus Development Corp's dominance of the spreadsheet market with 1-2-3 continues to decline as the number of Microsoft Excel for Windows users increases. Borland International Inc's Quattro Pro had the highest overall satisfaction score in the survey..."

Two quotes from a readers' survey on spreadsheets. Note that even though Borland was clearly the winner here, it was Microsoft that was fast overtaking the market. By using the phrase "WordPerfect of spreadsheets", even the author was clearly describing the quality of both programs. Quattro for Windows was also the winner of the PC Magazine's Technical Excellence Awards for 1992 (PC Magazine, December 22, 1992). So Microsoft certainly wasn't rapidly gaining market share because of the quality of its applications. Microsoft did rate high, but not as high as WordPerfect and Quattro Pro.

A later review of the 3 main suites (Three Suite Deals, original source: http://www.byte.com/art/9403/sec7/art1.htm, no longer available) in Byte magazine, March 1994, listed Lotus's SmartSuite as the best deal. "Lotus's SmartSuite clearly delivers the most programs for the money and is the best among these near-equals in terms of value." Nonetheless, quality can't overcome the distribution of Microsoft software by the computer manufacturers.

Microsoft has been distributing its software for years through OEMs, as evinced by the many ads, both old and new, for computer systems, which almost always included some version of Microsoft Office as part of the system. This is a form of predatory pricing. To establish a monopoly in the office suite, predatory pricing was the perfect method for Microsoft to use. Because Microsoft has had a de facto monopoly in PC operating systems for many years, and computer manufacturers, such as Dell and Gateway, needed the operating system to sell computers, Microsoft parlayed this relationship by having the PC manufacturers distribute Microsoft Office on each of their systems sold.

Indeed, the pressures that Microsoft exerted to promote Microsoft Office are illustrated by how it dealt with IBM. In 1995, IBM acquired Lotus Development Corporation, which had the Lotus SmartSuite that competed with Microsoft Office. Joachim Kempin was in charge of Microsoft's sales to the computer manufacturers. According to Judge Jackson's findings, Microsoft was going to delay the issuance of the license for Windows 95 to IBM to "resolve an ongoing audit of IBM's past royalty payments to Microsoft for several different operating systems." Paragraph 124 of Judge Jackson's findings of fact are particularly instructive:

124. On August 9, 1995, a senior executive at the IBM PC Company went to Redmond to meet with Joachim Kempin, the Microsoft executive in charge of the firm's sales to OEMs. At the meeting, Kempin offered to accept a single, lump-sum payment from IBM that would close all outstanding audits. The amount of this payment would be reduced if IBM offered a concession that Kempin could take back to Gates. As one possibility, Kempin suggested that IBM agree to not bundle SmartSuite with its PCs for a period of six months to one year. He explained that the prospect of IBM bundling SmartSuite with its PCs threatened the profit margins that Microsoft derived from Office and constituted a core issue in the relationship between the two companies. The IBM executive rejected Kempin's suggestion. In a follow-up letter, Kempin stated that Microsoft would require approximately $25 million from IBM in order to settle all outstanding audits. Kempin reiterated that, If you believe that the amount I am asking for is too much, I would be willing to trade certain relationship improving measures for the settlement charges and/or convert some of the amounts into marketing funds if IBM too agrees to promote Microsoft's software products together with their hardware offerings. The message was clear: IBM could resolve the impasse ostensibly blocking the issuance of a Windows 95 license --- the royalties audit --- by de-emphasizing those products of its own that competed with Microsoft and instead promoting Microsoft's products.

Note Kempin's concern about competition! Does this sound like a competitor or a monopolist? To tell a company—not only one of the largest companies in the world, but the very company that helped establish Microsoft's operating system monopoly in the first place—not to sell its own products! Only a monopoly could consider such an outrageous act; otherwise, how can Microsoft expect a company not to sell its own products that competed with Microsoft? Why would Microsoft think it had that kind of power except that the company was already well aware that it was a monopoly? And why did Microsoft want to prevent IBM from bundling SmartSuite for six months to a year? The only reason that would make sense is because by then, Microsoft Office would have a large enough share of the market to make it a standard, and then the other office suites wouldn't matter anymore. This characterizes the office-suite market today.

I purchased a Gateway 2000 computer on January 12, 1995. This is the invoice for that purchase (divided in 2 to keep the image size smaller, and to delete confidential information). The blue arrow head points to the entry for Office. I received Microsoft Office Professional 4.3, which included Access, Microsoft's database, and Money, Microsoft's financial package, for free. Today, Microsoft Office Professional 2000 retails for $599! The upgrade retails for $349!

"Our value choice for those who want to pay less than $2,500 is the $2,379 Dell Dimension XPS P133c. This system is outfitted with everything you need for basic computing tasks, and then some. Its features include a speedy 1GB Quantum Fireball hard disk and a Number Nine Motion 771 graphics adapter, which together helped it to achieve very competitive benchmark test scores within its 133-MHz CPU class.

"Dell also includes a 6X CD-ROM drive and Microsoft Office Professional for Windows 95 with Bookshelf. Add to this a three-year-parts and one-year-labor warranty and you have a great value choice."

This is an excerpt from the cover story of PC Magazine CD, Volume 4, Number 3, Fall 1996 edition, a review of Pentium PCs titled Pentium Classic: Still the One. This was the Dell Dimension XPS P133c, Editor's Choice for best value. As you can see, the latest edition of the full professional version of the then current MS Office is included with the system. The boldface emphasis in the excerpt is mine.

Click on the image to see a larger, cropped image.

This is a thumbnail image of a page from a May, 1999 Dell Computer Home Systems Catalog. Not only was the latest edition of MS Office 97 Small Business Edition distributed with many of their models, but they also included a FREE Office 2000 Upgrade in the summer of 1999. Although there are several pages of options that can be purchased with the computer systems, including extra software, nowhere in the catalog is there any itemization of MS Office, making it seem to the consumer that he is receiving it for free or no extra charge. In Dell's new April, 2000 catalog, Dell continues to distribute either MS Works or MS Office Small Business Edition with most of their systems. Most of these systems are also shipped with Money 2000, another software category that Microsoft wants to monopolize. Again, Money is not itemized, but you can also BUY Quicken 2000 Power Pack from this same catalog for $89. For new computer users, or users who haven't purchased finance software, why buy Quicken when Money is included with their purchase of a computer? Of course, the same factors that made MS Office a monopoly will eventually make Money a monopoly. More and more people will get Money, and therefore, won't get Quicken; there will be more books on Money, more third-party software for Money, more magazine articles talking about Money or explaining how to use it, thereby "advertising" Money to potential new users of financial software. Then it will become a standard, and so most people, thenceforth, will buy Money instead of Quicken. And naturally, since the latest edition of Money is being distributed, people who already have older versions of Quicken may decide to save themselves some money for an upgrade and just use the new version of Money, which can automatically import data from Quicken, so the switch won't be too inconvenient for the user.

I just received a new April 2000 catalog from Compaq computer. I called them at (800) 888-8450 about one of their systems, the Prosignia Desktop 340, for $1599. I asked them how much I could save if I didn't get the 17 inch monitor, and they told me $200+. Then I asked them how much I would save if I didn't get the MS Office 2000 Small Business Edition. I was told that not only couldn't I save anything, but I couldn't even get a computer without it being installed!!

How about if I try to configure my own system? Most major computer manufacturers let you do that, so I decided to go to http://www.dell4me.com (no longer available), specifically http://www.dell.com/html/us/segments/dhs/choose_dim_l.htm (no longer available). This was a fairly simple configuration page for the Dimension L series of computers, where I could choose the processor and which Microsoft software package I wanted, either Microsoft Office 2000 Small Business Edition or Microsoft Works Suite 2000, but since these options were radio buttons, I had to select one or the other. There was no option for none. By choosing the 550 MHz Pentium III for processor, the total system price with MS Office was $1,258.00; with MS Works and with all other options the same: $1,128.00. Thus, there is a $130 price difference, presumably for MS Office over MS Works. Clicking the configuration link led to a much more detailed page, where you can choose just about anything. Here, they included this drop-down box with the MS Office option:

Note that there is no option for none.

With the MS Works option, there was no option to select or deselect it. On the other hand, the drop-down box for the Norton Antivirus for both MS Office and Works was this:

Even though Norton was provided at no additional charge, nonetheless, the customer could select none if they wished.

Think of the profits that Microsoft could be making here. If people, who already have MS Office 2000, buy a new system that comes with MS Office 2000, and the OEM is paying Microsoft for this software, which seems likely, then these people are paying for MS Office AGAIN! This is reminiscent of the pre-consent decree days, when Microsoft was making the OEMs pay a per-processor royalty on Windows. In other words, the OEMs had to pay Microsoft for Windows for each computer they shipped, whether Windows was installed on the system or not. Even long after the consent decree, you could not buy a computer without Windows installed, and the OEMs wouldn't take it off for you, even if you requested it (An example of one user's attempt not to buy Windows, original source: http://www.essential.org/antitrust/ms/jun3survey.html, no longer available). Only recently have major OEMs, such as Dell, been offering Linux, or other alternatives, with their computers. A typical scenario that happens to many consumers, including myself, is that one would buy the latest upgrade to Windows, then, later on, decide to buy a new computer, too. And, of course, that would mean paying for Windows AGAIN! No wonder Microsoft is making so much money!

With computer manufacturers giving us options like these, which they have been doing for years, what chance does Corel or IBM ever have in selling their office-suite software? Will Intuit be the next victim?

Price Discrimination

A seller charging competing buyers different prices for the same commodity or discriminating in the provision of allowances — compensation for advertising and other services — may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the cost efficiency of those customers. However, price discrimination is lawful, if they reflect the different costs of dealing with different buyers or result from a seller’s attempts to meet a competitor’s prices or services. Price discrimination also might be used as a predatory pricing tactic—setting prices below cost to certain customers—to harm competition at the supplier’s level. Antitrust authorities use the same standards applied to predatory pricing claims under the Sherman Act and the FTC Act to evaluate allegations of price discrimination used for this purpose. Note that a firm in a competitive industry couldn't practice price discrimination, because such a firm is a price taker, so the firm must sell at the market price.

Price discrimination was one method of coercion that Microsoft used with the OEMs to have them distribute MS Office, part of the reason why these contracts were secret. Microsoft gave the lowest prices for its software, especially its operating systems, which every OEM needed, to those companies that were most compliant to Microsoft's wishes. Did the OEMs pay Microsoft for Office, or did Microsoft give it away, as it is currently doing with Internet Explorer? My Gateway invoice listed it as free, but the recent Dell ads seem to indicate that Microsoft is getting some money for Office. Of course, whether Microsoft got paid for Office by the OEMs may have changed over time, and depending on the OEM. What is clear is that Microsoft had the OEMs distribute MS Office to their customers as if the customer were getting it for free, or at no additional charge. In most of the computer ads and catalogs, the price for MS Office is not itemized, unlike some other peripherals, such as monitors. When a customer sees a certain price for a monitor that's itemized, the customer assumes that he can order the computer without the monitor, and save the cost of the monitor. But MS Office was almost never itemized like this in the ads; so most customers would think that they would not be saving anything by not getting MS Office; they would think that they're getting it for free, or at no extra charge. So even if Microsoft did receive payment by the OEMs for Office, the way the OEMs distributed Office gave the impression to most people that they were getting it for free. The effect of all of this is the same as predatory pricing, even if Microsoft were receiving payment for Office. The effect will certainly be the same for IBM and Corel—they won't be selling very many copies of their software. (According to http://www.computerworld.com/cwi/story/0,1199,NAV63_STO27310,00.html, which is no longer available, covering a consumer lawsuit filed against Microsoft about high prices, it was reported that Microsoft charged little or nothing for Word and Excel in the beginning to establish widespread distribution of its software, then, afterward, started charging the OEMs.)

How Microsoft Stifled DR-DOS Competition through OEM Licensing.

Digital Research Institute (DRI) developed DR-DOS to compete against MS-DOS. It was widely regarded as a superior product. Since Microsoft couldn't compete on the merits, it used anticompetitive means. Original source: http://www.drdos.com/fullstory/factstat.html (no longer available).

Exclusionary Licenses. During this 1990-1991 period, Microsoft also began deploying what would become its most effective weapon against DRI: exclusive licenses with OEMs. Although these licenses did not contain express exclusivity clauses, they utilized a collection of devices to create the same exclusive effect as an express contractual clause. Under these licenses, an OEM would have to pay Microsoft a royalty on every machine the OEM shipped regardless of whether the machine contained MS-DOS. This "per processor" term meant that an OEM could only ship a competing operating system if it was willing to pay twice: The OEM had to pay the maker of the competing system, such as DRI, and it had to pay Microsoft. Microsoft's licenses also required the OEM to make large minimum commitments with up-front payments for these commitments. Because Microsoft's pricing structure rewarded OEMs that made overly-optimistic minimum commitments, OEMs regularly had large pre-paid balances when their licenses expired. OEMs would forfeit these balances unless they renewed their license with Microsoft. Further tightening its stranglehold on OEMs , Microsoft dramatically increased the duration of these licenses to two, three, or even four years -- far in excess of the product life of MS-DOS versions. Microsoft's own documents show that these restrictive terms were introduced to ensure that no OEM could switch to DR DOS. In fact, almost no OEM that adopted one of Microsoft's restrictive licenses ever patronized DR DOS.

DR DOS expanded its market share slightly through 1991. In the Summer of 1991, DRI got a major boost in its effort to tackle Microsoft: DRI merged with Novell. This was a major competitive threat, and so Microsoft immediately tried to buy Novell. Novell ultimately refused. Microsoft responded with a vengeance, aiming its fury at the forthcoming version of DR DOS.

In the Fall of 1991, DRI/Novell released DR DOS 6.0, leapfrogging the features in MS-DOS 5.0 which Microsoft had released barely three months before. Microsoft pulled three special tricks out of its nasty bag to destroy DR DOS 6.0. 1. Beta Blacklist. Microsoft blacklisted DRI, and then Novell -- and ultimately anyone doing business with DR DOS -- from receiving test versions (or "betas") of Windows 3.1, which was being tested during the second half of 1991. Traditionally, software makers provide such test versions to makers of complimentary software so they can make appropriate changes to existing software and thus avoid huge compatibility problems every time a new piece of software is released. For example, DRI had used previous betas of Windows to assure consumers that DR DOS was compatible with Windows. But after cutting DRI and Novell off from the Windows 3.1 beta program, Microsoft made sure the world knew about it, and further sowed the seeds of concern about incompatibility between DR DOS and Windows by falsely stating it did not test DR DOS and thus could not ensure compatibility with Microsoft products like Windows. 2. AARD Code. In December 1991, Microsoft also inserted secret, encrypted code into the final Windows 3.1 beta -- a preview, marketing release -- that triggered a false error message whenever a computer was running DR DOS with Windows. 3. Intentional Incompatibility. Microsoft went further still, and designed both beta and released versions of Windows 3.1 to be incompatible with DR DOS simply to harm DRI.

Exclusionary Licenses and Tying. DRI's efforts to market DR DOS 6.0, also, collided head-on with the wall erected around OEMs by Microsoft's exclusionary licenses and tying of Windows and MS-DOS. While DRI and Novell tried to vigorously market DR DOS to OEMs during 1991 and 1992, OEMs simply could not afford to license DR DOS 6.0 even though it was a superior product. DR DOS 6.0 was cut off from the single most important customer base for operating systems.

Of course, another reason for the secrecy of the contracts between Microsoft and the OEMs was the nature of the licensing deals. If the public could read these contracts, they might be outraged by the unfairness of it (see parts of the agreement of Apple Computer and Microsoft below, and Microsoft's attempts to destroy DR-DOS in table above), and see clearly that Microsoft wasn't competing on quality, efficiency, or innovation; that, in fact, it wasn't competing at all. It was dictating what the public should have—their software. One of the constraints imposed by the 1995 consent decree indicates that Microsoft was using its operating system monopoly to get its other software distributed, and competitors' software not distributed. The decree obtained by the Department of Justice from Microsoft contained the following provision, under Section IV, Prohibited Conduct:

Microsoft is enjoined and restrained as follows: ... E. Microsoft shall not enter into any License Agreement in which the terms of that agreement are expressly or impliedly conditioned upon: (1) the licensing of any other Covered Product, Operating System Software product or other product ... or (2) the OEM not licensing, purchasing, using or distributing any non-Microsoft product.

This would indicate that Microsoft did use exclusive dealing and tying contracts to distribute its products; otherwise, why prohibit such conduct if Microsoft were not doing it. Judge Jackson's findings of fact also amply show price discrimination.

Since Microsoft is always saying that it competes on quality and innovation, then why have exclusive dealing and tying contracts, and price discrimination? Why use the tactics that Microsoft employed to destroy DR-DOS? Why pressure IBM to distribute Office rather than its own product? Why threaten Apple to include and make default Internet Explorer? Let the market decide, based on quality and features!

Microsoft Office was distributed by almost every major computer manufacturer, and thus, as more computers were sold each year, more and more people got Microsoft Office. And unlike most other software companies that gave beta software or older software away for free in the hope of getting upgrades, Microsoft distributed its current version.

Microsoft had an ideal situation. First-time computer buyers would already have Microsoft Office, so why spend hundreds of dollars to buy WordPerfect Office or SmartSuite? And if they already owned a computer and had an older version of WordPerfect or SmartSuite, why pay hundreds of dollars for an upgrade, since Microsoft distributed their latest edition of Office. But couldn't people just refrain from buying Microsoft Office, and just wait until they upgraded their computers to get the latest version of Office? Most systems are being shipped with less than full versions of MS Office, such as MS Word, or with Microsoft Works, a lesser version of Office (although some OEMs, since the consent decree, have been distributing non-Microsoft products, such as Corel WordPerfect). If Microsoft Works users want to upgrade, they are far more likely to buy MS Office, since they have already invested time and effort into learning Works. Microsoft's dominance of the market is so complete that it now even charges for beta software (http://www.microsoft.com/PressPass/features/1998/11-12office.asp)!

Would it not behoove the computer manufacturers to let the customer choose what software they wanted on their machines, especially when many people already have lots of software, and don't want their machines preloaded with unwanted or unneeded software, especially if they are paying for this software without realizing it? And by offering customers a choice of software, would this not help the OEMs sell their systems, especially in the days when WordPerfect, Lotus, and dBase were more popular than Microsoft's products? Had it been this way, then the people would have chosen what software they were receiving, not Microsoft.

Thus, predatory pricing worked wonders for Microsoft. At one time, WordPerfect and Lotus (part of SmartSuite) were far more popular than Microsoft's products. In fact, you might even remember dBase, that de facto standard of databases in years past! Or maybe not! So completely has Access supplanted it. Microsoft prevailed, not because its product was better, or because it was a more efficient company; it achieved its market share by leveraging its relationship with the computer manufacturers to distribute its software to every personal computer buyer, the only people who would need personal computer software. As more Microsoft software is distributed, the natural barriers to competition increase, particularly the network effect, thereby making it increasingly difficult for anyone to compete against Microsoft.

Predatory Pricing of Internet Explorer

Microsoft Specifically Intended to Use Predatory Pricing to Drive Netscape Out of Business

From the DIRECT TESTIMONY OF FRANKLIN M. FISHER (Source: http://www.usdoj.gov/atr/cases/f2000/2057.htm, no longer available)

(i) Brad Chase pointed out in April 1996, in a memo to Microsoft personnel who were responsible for preparing marketing plans: "This is a no revenue product, but you should worry about your browser share, as much as BillG because if you let your customers deploy Netscape Navigator, you loose [sic] the leadership on the desktop."

(ii) Mr. Chase went on to instruct: "You should go out to all the significant ISPs and on-line services in your country in May and close licensing agreements. You should also be able to break most of Netscape licensing deals and return them to our advantage because our browsers are free."

(iii) Under the heading "Own Corporate browser licensing," Mr. Chase noted: "This is one of the biggest potential revenue opportunities for Netscape. We should have absolute dominant browser share in the corporate space. Make it very clear it does not make any sense for them to buy Netscape Navigator." (4/4/96 re "FY97 Planning Memo: ‘Winning the Internet platform battle’," Brad Chase to FY97 WWSMM Attendees: Pl. Ex. 39, p. MS6 5005720.)

(iv) In May 1995, Microsoft’s Ben Slivka wrote: "If we don’t quickly become the supplier of choice for Internet technology, the Internet will grow and change under someone else’s influence, and we risk losing the standard setting role (with the attendant profit margins) we have come to enjoy with MS-DOS and Windows (and Office)." (5/27/95 "The Web is the Next Platform (version 5)," Pl. Ex. 21, p. MS98 0102396.)

125. Microsoft, at Bill Gates’s personal direction, undertook detailed studies of Netscape’s sources of revenue and what Netscape required to survive as an effective competitor. Microsoft estimated that at the time Microsoft made its decision to supply IE without charge, from 20 percent to 50 percent of Netscape’s revenues came from licensing its browser. (Bill Gates 8/27/98 Dep. Tr. 236.) Microsoft’s decision to price its browser below cost (indeed, at a zero or even negative price) was thus made when it knew that Netscape was charging for its browser and that Netscape depended on those revenues to continue to compete effectively.

(i) As Mr. Gates told The Financial Times in June 1996: "Our business model works even if all Internet software is free. We are still selling operating systems. What does Netscape’s business model look like? Not very good." (6/10/96 "Fight back at the seat of power," Hugo Dixon and Louise Kehoe, The Financial Times: Pl. Ex. 71, p. 4.)

From Microsoft's Own Research with Focus Groups Showing that the Best Way to Move Users from Netscape to IE was by Bundling the Browser with the Operating System

"Most of our IEUs were Navigator users. They said they would not switch, would not want to download IE4 to replace their Navigator browser. However, once everything is in the OS [operating system] and right there, integrated into the OS, 'in their face' so to speak, then they said they would use it because there would be no more need to use something 'separate'. The stunning insight is this: To make them switch away from Netscape, we need them to upgrade to Memphis [code name for Windows 98]. The good news is that there is enough value in Memphis that they would shell out even $89 for the upgrade. Due to methodological restrictions, we will test the price elasticity further in a quantitative survey."

Note that most businesses would have to consider the prices of their competitors, but Microsoft doesn't have to do that, since it has no effective competition. Note here, also, that Microsoft is actually recouping its costs for IE, because adding this new software to Windows allows Microsoft to maintain its high upgrade prices.

How Microsoft Coerced Intuit to Use IE and Forego All Business Relationships with Netscape.

From the DIRECT TESTIMONY OF William H. Harris, President and Chief Executive Officer of Intuit Inc. (Original source: http://www.justice.gov/atr/cases/f2000/2055.pdf, no longer available.)

Oct 13, 1998

6. Intuit entered into an Agreement to promote Microsoft Internet Explorer to the express exclusion of Netscape Navigator and to forego any business relationships with Netscape, because Microsoft guaranteed Intuit placement on the Windows desktop for Intuit’s Internet-based products and services. However, during the negotiations it was made clear to me that promotion of Intuit’s Internet content on the Windows desktop was conditioned on our agreement to forego business relationships with Microsoft’s browser competitor, Netscape, including our then-existing arrangement to distribute and promote Navigator.

33. ...It is well understood in our industry, as in others, that customers are more likely to purchase or use what they see first and what they see by default (without making an explicit choice). ...Indeed, the three most important success factors often cited by many types of retailers in the physical world are "location, location, location". The same holds true in the electronic world.

34. In fact, I believe that the importance of prominent placement is even greater in the electronic world than in the physical world. This is because the Internet is an interactive medium, which can provide both advertising and fulfillment functions. In other words, a customer can both learn of and order a product on the Internet. Thus, for instance, it [the desktop] can serve the functions of both television advertising and supermarket distribution in the traditional physical world.

36. Through its Windows operating system and the Internet Explorer browser, Microsoft has the power to control product placement for access to Internet web sites. Creating a "bias" on the screen in front of the computer user gives Microsoft substantial power to direct users to particular products, services and web sites.

40. ...A high proportion of users of personal finance software use Quicken, just as a high proportion of PC users run the Windows operating system. However, the switching costs are vastly different. To switch from Windows to the Macintosh operating system requires many hundreds or thousands of dollars in new hardware costs, a completely new set of software applications, and the hassle of relearning both the new operating system and the new software. Because so many things depend upon the operating system, switching to a new operating system requires all those things to change as well.

41. By contrast, switching from Quicken to Microsoft Money requires only a copy of Money. In Microsoft’s own words, Quicken data can "painlessly and seamlessly" be imported into Money, Microsoft "makes it a snap" for Quicken users to use Money, and Money is "easy to use and learn." Therefore, the barriers to switching are relatively low.

44. ...Given the dramatic increase in the quantity of operating system licenses sold over the past eight years, the fact that the cost of an operating system license has not declined significantly during this period is one indication of the absence of effective price competition.

45. Another indication of the lack of effective competition is Microsoft’s astonishing profitability. As a basis of comparison, I prepared an analysis of the average pre-tax profitability, as a percent of revenue, for the 473 U.S. companies with annual revenues greater than $3 billion, based on the most recent public financial statements on file (See, Gov. Ex 1216, Financial data from PeerScape website). The average pre-tax profitability of these large companies is 9%. (Intuit’s profitability is also in about this range.) Very few companies – less than eight percent of all large companies in America – exceed 20% profitability. Only five companies exceed 30% profitability. But Microsoft exceeds all the others with the record-high profitability for a large corporation in the modern era: 49%, and steadily climbing (See, Gov. Ex. 1217, Financial History Pivot Table). As a businessperson, I find it hard to explain such abnormally high profitability, except in a market substantially insulated from effective competition.

47. ...Intuit has experienced three major episodes during which we have been directly impacted by Microsoft’s power to leverage their operating system control: (1) WinATM in 1994, (2) the Active Desktop in 1997, and (3) the Start Page in 1998.

48. In 1994, Intuit was approached repeatedly by Bill Gates at Microsoft regarding his interest in acquiring Intuit. In our internal deliberations, important consideration was given to the ways in which Microsoft could compete with us if we resisted the acquisition offer. At that time, Microsoft already had a history of bundling into the operating system various software functionality that had previously been sold separately by other companies. This had seriously impacted the businesses of software developers such as Symantec, Central Point, Stac, and others.

49. We were therefore concerned that Microsoft might similarly bundle personal finance functionality with the operating system. In fact, we had heard rumors that they were working on such a project. Such bundling would have seriously impacted our ability to sell Quicken, which was then our largest and most profitable business. In addition, we were then investing very significant resources in building an online banking network, which would electronically connect PC users to their financial institutions. If Microsoft bundled online banking functionality with the operating system, thereby making it the default service available to all Windows users, it would have seriously impacted our ability to attract PC users or financial institutions to our service.

50. ...in the summer of 1994, Intuit founder and chairman Scott Cook wrote the following: Microsoft "can attack us in either or both of two ways: (1) Traditional way: develop and market financial products reasonably independently of their other assets, and (2) All-out attack: make full use of their many and unique assets, such as the OS [operating system], other application software, and Marvel [the Microsoft Network]. We fear the second approach. That’s the focus of this assessment."

51. Mr. Gates’ acquisition proposal to Intuit came at about the time Microsoft was finalizing a consent decree with the Department of Justice which prohibited certain conduct by Microsoft. In his conversations with Intuit, Mr. Gates indicated that he felt his settlement with the government had cleared up potential uncertainty as to his ability to move forward aggressively on numerous fronts, including an acquisition such as Intuit. In the same memo to the Board, Mr. Cook said of Microsoft: "Recently overcame last barrier to OS [operating system] monopoly. My judgment: Yet to see full benefits from OS monopoly."

53. After Microsoft abandoned its attempt to acquire Intuit, we were told by Pete Kight, the CEO of CheckFree Corporation, that Microsoft had in fact approached CheckFree and MasterCard International with plans to create a product they called "WinATM". Mr. Kight disclosed this information to me because Intuit subsequently became CheckFree’s largest shareholder, and I am Intuit’s representative to the CheckFree Board of Directors. According to Mr. Kight, WinATM was to have been created by starting with Microsoft Money, Microsoft’s personal finance software, and stripping away some non-essential features. In fact, the WinATM project was run by the Microsoft Money team. WinATM was to include (1) checkbook register functionality (the fundamental customer benefit in a product such as Microsoft Money or Quicken), (2) electronic data download functionality (the ability to get account balance and statement data electronically from financial institutions), and (3) electronic bill payment functionality (the electronic equivalent of writing a check). WinATM was to be bundled with the operating system, so that it would be universally and freely available and be the default option for personal finance and online banking and payment activities for all users of the Windows operating system.

54. Mr. Kight told us that, in early 1994, there had been numerous meetings at Microsoft’s headquarters in Redmond between representatives of Microsoft, CheckFree and MasterCard. The most senior level meeting was attended by Nathan Myrvold and, briefly, Steve Ballmer of Microsoft; Pete Hart, CEO of MasterCard; and Mr. Kight. Microsoft proposed to connect to MasterCard’s national ATM network for electronic data access and to CheckFree for electronic bill payment services. Microsoft representatives explained to Mr. Kight that, by bundling this functionality into the operating system, they would automatically enable every Windows PC user with the functionality, thus: (1) making any competitive offerings irrelevant, and (2) giving the banks "no choice" but to work with them. (Author's Note: What do you think, folks? Does this not show unambiguously that Microsoft recognizes itself as a monopoly? Sure, Microsoft isn't going to admit it in public, any more than a bank robber is going to admit that he robs banks!) The Microsoft representatives wanted to move quickly, in order to be able to bundle the functionality into the upcoming "Win95" version of the operating system, which was ultimately released in August 1995.

55. According to Mr. Kight, after the Intuit acquisition agreement was announced, representatives from the Microsoft Money team said that Mr. Gates had decided that, if Microsoft was going to bundle personal finance functionality with the operating system, he preferred to do so using the most popular such product (Quicken).

57. In a move that was publicly described as an attempt to make the desktop interface of the Windows operating system become the primary gateway to the Internet, in 1997 Microsoft developed a feature in Internet Explorer called the Active Desktop. The Active Desktop was intended to be a new user interface for Windows that would, among other things: (a) permit direct access to the Internet; (b) provide a choice of Internet web sites that could be directly accessed from the desktop; and (c) permit the user to view Internet content on the desktop itself without separately opening the browser. With the Active Desktop, Microsoft aimed to turn the Windows desktop into a Microsoft-controlled gateway to the Internet – a gateway that would be seen by almost every PC user.

59. For Intuit, this represented the same threat we had considered during the WinATM episode – the possibility that Microsoft would bundle its own financial products with the operating system. We believed it was critical for us to have our financial products distributed with the operating system, as well.

61. Placement on that portal [Active Desktop] was critical to Intuit because it meant potentially having access to millions of PC users. Also, not having such placement would mean that Intuit would no longer be on equal footing with the competing financial sites of Microsoft or its favored partners. During negotiations of an agreement by which Intuit could obtain priority placement for its web sites on the Active Desktop, however, Intuit learned that any such agreement would require, as a condition, that Intuit forego any business relationships with Netscape, Microsoft’s principal competitor in the browser market. Because placement on Microsoft’s Active Desktop was believed by Intuit at the time to be critical to the success of its web sites, Intuit felt constrained to agree to this condition.

65. ...Intuit would have been prepared to pay a substantial fee for the placement [on the Active Desktop], even greater than what Intuit has paid other portals and web sites for prominent position, but Microsoft offered us this placement instead in return for our agreement to forego future business dealings with Netscape. (Microsoft obviously wants to get rid of Netscape badly! Microsoft wanted to get rid of Netscape so badly that they were even willing to give Intuit prominent placement right next to Microsoft Money and Microsoft Investor, Microsoft's own competing products. Understandable. Microsoft wants to control your gateway to the Internet! Microsoft doesn't want to ask you the question, "Where do you want to go today?" It wants to command "This is where you will go today!")

68. During the negotiations, Mr. Poole advised me that Bill Gates had personally stated two preconditions for any agreements that would give an Internet content provider like Intuit access to preferential position on the Active Desktop. First, the agreement could only be one year in duration. (In an internal email to me from Eric Dunn dated March 27, 1997, Eric Dunn stated, "[Poole] claims that Bill Gates has ordained the "first year only" rule, and that [Poole] can’t consider anything longer. (See, Gov. Ex. 1044, March 27, 1997, Eric Dunn Email) Second, the agreement would have to preclude the Internet content provider from dealing with Netscape. (The one-year rule seems reasonably for a monopolist. After all, once Netscape is gone, why is Microsoft going to need Intuit? And why would they bother to continue to allow Intuit to compete with their own products on their own Desktop?) ...Mr. Gates had mandated that all preferred participants on the Active Desktop must agree to cease working with Netscape as a condition of that participation.

70. The agreement between Intuit and Microsoft contained several specific restrictions concerning Intuit’s ability to deal with Microsoft’s competitors. Specifically, the agreement placed limitations on Intuit’s ability to work and deal with [Netscape].

71. The Active Desktop Agreement prevented Intuit from promoting Netscape on Intuit’s web sites, or allowing Intuit’s web site customers to access Netscape’s products or services.. For example, prior to the agreement, Intuit had promoted Netscape by placing a Netscape Navigator download button and link on Intuit’s web site. The agreement required Intuit to take those buttons and links off the web site, and replace them with download buttons and links for Microsoft Internet Explorer. In the absence of that requirement, Intuit would have continued to promote Netscape’s download buttons and links on its web site.

72. The agreement also required Intuit to distribute "Internet Explorer and no Other Browser as an integral part of the release of any and all new and major releases of Intuit Products . . . ."(See Gov.’t Ex. 1156,Section 2.2(a)). Prior to this agreement, Intuit had been distributing Netscape Navigator with Quicken, TurboTax, and QuickBooks, on both the Windows and Macintosh platforms. The agreement thus precluded Intuit from further including Netscape Navigator in copies of Intuit’s applications.

73. The agreement also required Intuit to deploy certain Microsoft-specific technologies, such as Microsoft’s Channel Definition Format, Dynamic HTML, and ActiveX. Content developed with those technologies can be viewed through Internet Explorer, but will not be accessible by other browsers. Intuit generally tries to design its web site so that it is accessible from any browser, to insure that it can be accessed by the largest possible number of customers. Thus, the requirement in the Active Desktop agreement to utilize Microsoft specific technologies was an exception to Intuit’s general practice of making its content broadly accessible.

74. Finally, the agreement effectively precluded Intuit from entering into a business relationship with Netscape to promote or distribute Intuit’s content through any Netscape Internet service or browser product. Specifically, the agreement required that Intuit not enter into any "Content Promotion Agreements." A content promotion agreement was defined as: "an agreement with (i) a company (or its Affiliates) which produces Other Browsers or (ii) an agreement with any third party in which economic and other benefits are passed through materially unchanged to a company which produces Other Browsers and in which the third party performs no substantive function with respect to the agreement except to be a pass-through entity . . ., which agreement is to exchange money or other material and valuable consideration (such as the promotion, marketing or distribution of Other Browsers) in return for distribution, transmission, marketing or promotion . . . of Intuit Content or logos . . . ." (See Gov’t.Ex. 1156, Section 2.2 (d)).

75. Thus, while the agreement on its face appears to permit Intuit to allow Netscape to distribute Intuit’s content, it made it uneconomic to do so, as it prohibited either party from conveying to the other, either directly or indirectly, any payment or other consideration.

93. ...[Microsoft can] promote proprietary web standards that will not operate in other browsers, as they have done in the Active Desktop Agreement. (Once Netscape is sufficiently minimized, Microsoft will be the standard setter on the Internet, not the W3C. Then Microsoft will be able to eliminate any competition whatsoever by developing proprietary technologies that only work in IE. Needless to say, by being the standard setter, Microsoft's IE will always be ahead of any other browser, not because Microsoft is the best, but because it will know the standards beforehand, and therefore will be first and "better". This situation is similar to the time when Microsoft developed OLE 2.0, and MS Office was the first to use it, thereby gaining an important advantage in the office-suite war.)

98. Control of the dominant computer operating system can thus be leveraged into significant influence over and/or actual control of major areas of electronic commerce and communications. For example, by exclusively promoting MSNBC (Microsoft’s news service) on the Start page, Microsoft has now made MSNBC the default news provider on the dominant operating system. This will enable Microsoft to preferentially direct almost all personal computer users to its own flavor of news coverage, and deny similar favored access to other news sources such as ABC, CBS, CNN, Knight Ridder, Time Warner, the New York Times, the Washington Post, and others throughout the country.

99. As further examples, by exclusively promoting Microsoft Expedia on the Start page, Microsoft has now made it the default travel booking service on the dominant operating system. By exclusively promoting Microsoft CarPoint, Microsoft has now made it the default car buying service. By exclusively promoting Microsoft Hotmail, Microsoft has now made it the default electronic mail system. By exclusively promoting Microsoft Investor, Microsoft has now made it the default investment service. By stating that it will exclusively promote TransPoint (formerly MSFDC), Microsoft has indicated that it intends to make it the default electronic billing and bill payment service.

Much of this didn't materialize because either it was less successful than Microsoft hoped or because of intense scrutiny by the Senate, the DOJ, and the press. Nonetheless, it does show unequivocally Microsoft's pattern of behavior, that it doesn't want to compete on innovation, quality, and prices. It doesn't want to compete at all. It wants to be a monopoly that doesn't have to consider any competition. Microsoft wants to be free to set prices.

How Microsoft Coerced Apple Computer to Make IE the Default Browser on Macintosh Computers

From the Deposition of Avadis Tevanian, Jr., Senior Vice President of Software Engineering for Apple Computer(Original Source: http://www.zdnet.com/zdnn/special/msdojdepos/aptevanian1.html, no longer available.)

This lengthy document shows that:

1. Microsoft wanted Apple to bundle IE with the Mac OS and make it the default browser.

2. It was important that IE be the default browser because most people use the default browser, and many of them don’t know how to change the default. These facts were garnered from customer feedback.

3. IE was bundled with Mac OS 8.0, but not made the default, which bothered Microsoft.

4. Brad Silverberg of Microsoft made it clear to Apple that if Apple did not agree to make IE the default browser, then support for Office on the Mac would be withdrawn.

5. Tevanian gave 2 reasons why support for Office on the Mac was necessary, and suggested that Apple even needs Microsoft:

“The first reason is Office is the de facto program for anyone who does anything with an Office suite both on the Mac and the Windows platform, so anyone who needs to have that kind of functionality basically uses Office these days. There are some exceptions and there are some other products, but it's so important a product that you can't have a viable platform without it.

“The second reason why this was very important to Apple to have continuing development on Office was because the current version of Microsoft Office available for the Mac was really bad, and there were many, many customer complaints about it, performance problems, lots of stability problems, just causing lots of angst in our customer base, and without a new, upgraded version of Office, our customers would have been stuck with the older version.” (I guess this is an example of the Microsoft quality that Microsoft and supporters continually allude to.)

"Q. Would Microsoft's withdrawal of support for Office, did anyone ever say to you that Microsoft's withdrawal of support could send Apple into a death spiral?"

"A. ...well, lots of people knew that the loss of Microsoft as an ISV [independent software vendor] would be devastating, and the fundamental reason for that is, getting back to the ISV question or the ISV issue again, if the biggest ISV wants to abandon the platform, then why should other people support the platform? And if you don't have any ISVs, you don't have a platform."

Quotes from the license agreement between Apple and Microsoft:

"For so long as Microsoft is in compliance with Section 2.1 above and has not elected to cease future development and releases of Microsoft Office for Macintosh under the circumstances permitted under Section 2.3 above, Apple shall bundle the most current version of Microsoft's Internet Explorer for Macintosh provided by Microsoft to Apple under Section 3.4 below with all system software releases for Macintosh Computers ('Mac OS').

"Q. "'Any other Internet browsers bundled in the Mac OS system software sold by Apple shall be placed in folders in the software as released.' What does that mean?"

"A. So the -- Microsoft's goal there was to make sure that we would not be allowed to place another browser icon on the desktop other than IE or the default "browse the Internet" icon, so other browsers could only be hidden underneath the file system hierarchy."

"Apple will use reasonable efforts to ensure that parties having a license to reproduce and market the OS abide by the terms and conditions of the Section 3.1 if permissible under existing licenses."

Microsoft wants to dictate to Apple employees what browser they should use:

"In addition, for so long as Apple is bundling Internet Explorer for the Macintosh, Apple will encourage its employees to use Microsoft Internet Explorer for Macintosh for all Apple-sponsored events and will not promote another browser to its employees."

"Q. Do you understand this agreement to affect Apple's ability to promote Netscape Navigator in conjunction with the marketing of any of your products?"

"A. My understanding is this doesn't allow us to promote Netscape Navigator, so yes."

The agreement between Microsoft and Apple specified, amongst other things, that in return for making IE the default browser, Apple would receive a $150 million investment from Microsoft and Microsoft would continue to develop Office for Apple for at least 5 years. (News Alert: Microsoft has recently made a major investment in Corel to prevent it from going under, thereby enabling Microsoft to maintain a guise of competition that Corel partly offered. Why else would Microsoft invest in competitors?)

Is Microsoft competing fairly with Netscape? I don't see how anyone could possibly think so. Why should Microsoft coerce Apple to distribute its browser? Why not just let Apple decide which is the best browser, and allow it to make its own decisions? Apple has a compelling interest in providing the best products with its computers, because having better software products will help Apple to sell more computers.

But why should Microsoft go to such extreme lengths of promoting its browser when it isn't receiving a penny for it from Apple? Microsoft certainly can't claim that IE is part of the Mac OS! The only reason that would make sense is because Microsoft wants to monopolize the browser market.

Much of the current debate about Internet Explorer and Netscape focused about whether Microsoft's practice of giving away software was good for the consumer. Free software would seem to be good for the consumer. This is a great marketing gimmick for Microsoft, for many people like Microsoft for this reason. Indeed, this is one reason why the Justice Department did little or nothing about Microsoft for years. And while Judge Jackson's findings of fact do depend on much testimony and the credibility of witnesses, no such detailed examination and cross-examination is necessary to see what Microsoft has done with Office. The evidence is plainly visible to anyone who wishes to look, and it isn't disputable.

Marginal Cost

The additional cost of producing 1 extra unit of product. The marginal cost of retail software is the cost of the packaging and its physical contents, but doesn't include software development costs, or other costs of production. If the software is distributed by licensing or the Internet, then the marginal cost of software is zero, or nearly so.

I'm sure when the consumer was getting Microsoft Office for free (or he thought he was getting it for free), the consumer felt he was benefiting, but clearly the free lunch has ended. Microsoft is now reaping the rewards of the end game in predatory pricing, by being able to charge prices far above its costs, and without regard to the competition. Office is now Microsoft's most profitable product, even more profitable than its operating systems. The consumer is being milked, and the digital divide that is being reported frequently in the press, and addressed by President Clinton in his State of the Union speech (the government even put up a special site to address the issue: http://www.digitaldivide.gov/), that divide that separates the digitally literate who can afford computers and software from those who can't, will be wider because of the prices of Microsoft software. This is especially true in other countries, where people are much poorer and Microsoft's prices are even higher. If Bill Gates truly wanted to bring computing power to the masses, he could do no better than reducing the price of software as the installed base expands. Here's an interesting quote from Bill Gates: "Maybe kids of a certain age or people of a certain income should get to access intellectual property royalty free or royalty reduced. Why not? There is no marginal cost." Exactly!

Microsoft's distribution of IE is predatory pricing. Not only is Microsoft not receiving any direct revenue from its distribution of IE, it's actually spending a lot of money developing and promoting it, more than $600 million so far. Thus, IE's cost is actually negative. From the start, Microsoft offered its browser for free in an effort to establish a monopoly in browser software. Furthermore, Internet Explorer was mainly distributed by the computer manufacturers, just as Microsoft Office was. And just as before, Microsoft's main competition, in this case, Netscape, will be minimized. After all, what other result was possible when Netscape's major revenue source was being diminished because Microsoft was giving its browser away for free. Microsoft understood exactly what it was doing. Bill Gates said it clearly in an interview published in the Financial Times on July 3, 1996: "Our business model works even if all Internet software is free," says Mr. Gates. "We are still selling operating systems. What does Netscape's business model look like if that happens? Not very good."

Obviously!

Microsoft argues that even if IE and the operating system are separate products, distributing IE for free isn't predatory pricing, because it is not recouping its costs. Microsoft is actually recouping its costs (see below), but, even if it weren't, recoupment of costs need not be a fait accompli. There only needs to be a dangerous probability of succeeding at recoupment, and, let's face it, if Netscape is eliminated, what's to stop Microsoft from subsequently charging for IE. But, as argued later, Microsoft is recouping its $600 million dollar investment in IE, by allowing Microsoft to maintain its high upgrade prices for Windows.

Windows and Internet Explorer Are Separate Products

In its conclusion of law, Microsoft argues that the browser is actually part of the operating system. Microsoft relies heavily on the Court of Appeals decision (147 F.3d at 951) (Original source: http://www.cadc.uscourts.gov/common/opinions/199806/97-5343a.txt, no longer available) it obtained earlier. That decision stated that there is nothing wrong integrating two products if it is beneficial to the consumer. Wouldn't it be beneficial to integrate Microsoft Office with the operating system? Or any other software product for that matter? Clearly this ludicrous decision doesn't distinguish between separate products. With a decision like this, Microsoft can tie any product it wishes into the operating system.

The appeals court specifically argued that computer manufacturers couldn't combine the operating system and Netscape in the same way that Microsoft combined Internet Explorer with the operating system. It even cited this specific example: "Windows 95 without IE's code will not boot, and adding a rival browser will not fix this." (Id. at 948 n.11) First, it's obvious that since Microsoft develops both operating system and browser, it can easily arrange this. Second, nothing inherent in the boot sequence requires browser code. Operating systems have been booting up long before there were any browsers. In fact, when I bought my retail copy of Windows 95 shortly after it came out, it didn't even have Internet Explorer! So how could it be required for the boot sequence, and indeed, what aspect of the boot sequence would require browser code?

The appeals court made another dubious argument, which Microsoft argued in its conclusions of law:

'The Court of Appeals held, however, that the relevant test is not whether the benefits of integration could be duplicated by combining Windows 95 and Internet Explorer 4.0, but rather whether the benefits could be duplicated by combining an operating system with "a stand-alone browser such as Netscape's Navigator."'

But isn't Internet Explorer a stand-alone browser? There's an Internet Explorer for both the Macintosh and Unix operating systems! Clearly, IE isn't a part of those operating systems, so, perforce, it must be a separate software product!

A more probative approach to determine whether the browser is separate from the operating system is to look at the fact that there was a company, Netscape, that was selling a browser, but not an operating system. Opera is another browser that isn't distributed with its own operating system. Even Microsoft sold Internet Explorer separately, in its own shrink-wrapped box. Indeed, Microsoft's own book publishing company, Microsoft Press, publishes books that have CD-ROMs with the complete Internet Explorer software. One of the goals of antitrust law is to foster competition. If there are separate companies selling a similar product, then isn't that prima facie evidence that they're separate products? And certainly, in view of the goals of antitrust law, particularly that of promoting competition among companies, shouldn't this be the accepted definition—the bright line—that would best promote public policy?

Why IE is Sold as Part of the Operating System, but Microsoft Plus! 98 is Sold as a Separate Product

Microsoft® Plus! 98 is the ideal companion to the Windows® 98 operating system. Plus! 98 extends the advanced functionality in Windows by adding utilities, themes, and games to let you further manage, customize, and enjoy your PC.

This is how Microsoft describes its product, Microsoft Plus! 98. Why isn't this a part of the operating system? With features such as McAfee VirusScan®, desktop themes, file cleaner, Start menu cleaner, and Compressed folders, this product would seem to be more a part of the operating system than IE, yet Microsoft sells this package separately for $44.95, almost half of what Windows 98 itself costs! Microsoft argues that it is including IE in the operating system because it benefits consumers. Wouldn't incorporating Plus! 98 into Windows 98 instead of making it a "companion" benefit consumers?

In fact, according to Microsoft's own research with focus groups for Windows 98, one of the most requested features for the new OS was an anti-virus program that could be updated over the Internet. Why didn't Microsoft include an anti-virus product with any edition of Windows, especially considering that almost all of the viruses today take advantage of Microsoft security holes? Since this was one of the most requested features, Microsoft saw this as another opportunity to increase its revenue at the expense of the public. True competition would have compelled Microsoft to include an anti-virus program and make the OS less vulnerable to viruses.

So if Microsoft is giving us such great software updates with IE for free, then why is it charging us for small improvements in other areas of the operating system? And why sell a "companion" such as Plus! 98 for even more money when it could obviously just be included with the operating system? Again, the only rational explanation is that Microsoft wants to monopolize the browser market, not to benefit consumers. This is the only explanation that would explain Microsoft's behavior in any sensible way! This is a clear violation of the Sherman Antitrust Act and the Robinson-Patman Act.

Piracy as a Form of Predatory Pricing

Ironically, piracy can be an effective way of establishing a monopoly, working in the same way as predatory pricing. Although Microsoft probably doesn't intend to establish its monopoly in China this way, its inability to stem piracy now may benefit Microsoft in the future. The wide dissemination of pirated Microsoft software will help to standardize the software in China, and augment the other natural barriers to competition. If technical and political advances allow Microsoft to enforce the law more vigorously in the future, this may yield a windfall for Microsoft. If Microsoft succeeded in enforcing the law today, it would thwart software distribution significantly, since most Chinese can't afford to pay Microsoft's exorbitant prices. More importantly, since China is a communist country and controls business to a much greater extent than the government does in the United States, China may decide to force the country to standardize on open source and free software, such as Linux and StarOffice rather than shell out billions to an American company, much as France intends to do (Original source: http://www.independent.co.uk/?story=42482, no longer available)! On the other hand, as the natural barriers to competition become stronger with greater distribution of pirated software, then Microsoft software will become so entrenched in homes and businesses—and even the government—that not even the Chinese government will be able to change it.

Predatory Pricing is the Perfect Method to Establish a Software Monopoly

It would cost too much for the predator, since the predator would be selling at below-cost, and the larger the company, the greater the loss it would incur, because of its higher sales volume.

The predator couldn't know how long the price war would last. It would be foolish to sell at a loss in the hope of making monopoly profits in the uncertain future.

There is nothing to stop the competition from shutting down until prices rose again after the would-be monopolist attempted to recoup its losses. Even if the monopolist bankrupted its competitors, new competitors would enter the market when the monopolist started charging much higher rates.

The theory of predatory pricing assumes the prior existence of a "war chest of monopoly profits" that the predator can use to subsidize its practice of pricing below average cost. But how does that war chest come into being if the firm has not yet become a monopoly?

The opportunity cost of the money used for predation needs to be taken into account. Later monopolistic profits would have to yield a greater rate of return than any other investment for the company; otherwise it wouldn't be rational for a company to attempt predatory pricing.

It is easy to see why these arguments fail with Microsoft. Not only do these arguments NOT show that predatory pricing is a myth, but that, in fact, predatory pricing is the perfect method to establish a software monopoly!

When Microsoft has the OEMs distribute its software, Microsoft's cost is zero. The OEMs pay for distribution and supplemental materials such as books. And because Microsoft makes plenty of money from its operating systems and from retail sales, it doesn't have to wait until its competitors are eliminated. Indeed, once customers and businesses start using Microsoft software, Microsoft can sell upgrades at a high price because of the network and investment effect, regardless of the presence of competitors. If Microsoft includes software as part of its operating system or other software as it has done with IE, then that cost is already covered by the extremely high price of Microsoft's software. Microsoft doesn't have to worry about any new competitors entering into the market, because of the natural barriers to competition that only become stronger with greater distribution of Microsoft software. And, of course, Microsoft's "war chest" could have come from its operating system monopoly that IBM gave it, if it needed it, but Microsoft doesn't need it, because the marginal cost of its software as distributed by OEMs is zero. And since Microsoft's software prices are many times what its costs (more than 33 times in the case of Office!), Microsoft would never be able to find any other investment that would yield the rate of return that Microsoft is achieving with its monopoly, and the proof is in its profits.

Economists are finally seeing clearly that predatory pricing works, and in the software industry, it works beautifully. The question is, will the courts see the truly harmful effect of predatory pricing?

Clearly, antitrust laws are needed today more than ever.

Because the Marginal Utility of Software Upgrades is Declining, Microsoft has been and will be Forced to Include More and More Software in Each of its Packages

Marginal Utility

The extra satisfaction gained from an additional unit of a good or service. Marginal utility usually declines with each additional unit.

Declining marginal utility of software upgrades—not generosity!—is what's forcing Microsoft to include more software for the consumer dollar, and since Microsoft wants to monopolize the browser market and control the Internet, IE was a natural choice to include in Windows. People aren’t going to pay Microsoft’s high upgrade prices just for a more stable Windows, or for fixes and modest improvements. That’s also why Microsoft added PhotoDraw and FrontPage (and now, Visio 2000) to Microsoft Office Premium Edition, so that it can maintain its high upgrade price and still have decent sales. Years ago, people upgraded constantly because computer systems and software had serious limitations, but now that both hardware and software satisfy the needs of most people, the demand curve is shifting, and the price for maximum profits is declining. And, of course, piracy, which is rampant in poorer countries, will be more pervasive at higher prices. Nonetheless, prices haven't dropped nearly as much nor as fast as they would have if Microsoft had true competition.

So by including IE in Windows, Microsoft is recouping its costs for IE; it’s just not itemizing the revenue. Without the inclusion of additional software, Microsoft would have had to charge a lower price for Windows. (Although it is true that people can download IE for free, many people don't. They would rather buy it as a complete package, and not worry about download times or installation problems.) And since IE is part of the operating system, and Microsoft has raised prices on its OS yet again (Windows 2000 is the most expensive operating system ever, and, eventually, Microsoft wants to move everyone up to it.), do you think Microsoft is making a profit? Absolutely! And a hefty one at that. Microsoft said it spent $1 billion developing Windows 2000. Since Microsoft already said that it spent $600 million developing IE and IE is part of Windows 2000, then more than half of the development costs went to IE. Ergo, Microsoft is recouping its costs through the revenue it obtains from the operating system. (Although Microsoft is also getting advertising revenue from IE, this is only a small fraction of the revenue obtained from the sales of Windows itself. Netscape was getting advertising revenue, also, but this revenue wasn't sufficient to cover development, marketing, and distribution costs, as Microsoft noted in its own research! Thus, without retail sales, Microsoft knew that Netscape would either be bankrupted or seriously weakened.)

As a Monopolist, Microsoft Adds as Little Value as Possible To Each Upgrade It Sells, and Not to Upgrade Too Quickly.

Bill Gates, November 29, 1989: "While DOS continues to be our most important and most profitable product over the last four years we have done very little with it technically." (Original source: http://www.drdos.com/fullstory/factstat.html, no longer available.)

Bill Gates (before the Committee on the Judiciary, United States Senate, March 3, 1998): "A monopolist is lazy, charging prices above competitive levels for products that are rarely improved because no one else can offer alternative products to consumers." (Original source: http://www.corpwatch.org/trac/feature/microsoft/monopoly/gates.html, no longer available.)

While Microsoft will be forced to include more software for the consumer's dollar, it will do so as slowly and as little as possible. If Microsoft tried to raise prices for its software, people would balk. People would ask why software prices are going up while hardware prices are plummeting, creating bad public relations for Microsoft. It doesn’t want any more scrutiny into its practices than is already occurring. The solution, of course, is to keep prices the same, but only add enough value to each upgrade to make the price look at least a little reasonable. And it can also create separate products, such as Microsoft Plus! 98, to generate more revenue. It could have easily added Plus! 98 features to Windows 98, but that would be adding too much value. Microsoft wants people to get the least amount for their money. Eventually, of course, Microsoft will add the Plus pack features into the operating system, because, as I have said, it has no choice. But the mere existence of the Plus pack just shows that Microsoft really does want to stretch out the upgrade cycle, by adding the least value at the greatest cost to the customer! Thus, Microsoft earns a higher rate of return on its development costs even without raising prices. Microsoft is helped in this by the buzz created by computer magazines. Magazines are always looking for new material, and obviously, new editions of software provide that material. The magazines write about the new software, give tips on how to use it, and, in effect, help Microsoft sell its wares.

Why wouldn’t Microsoft upgrade faster? If upgrades came out too fast, people would probably scrutinize the cost-effectiveness of the upgrades more. Moreover, upgrades take time to sell. If Microsoft upgraded too quickly, people who were slow to purchase would just skip the intervening upgrade and buy the new upgrade that just came out. Consumers may also delay their purchase because of anticipation of a new upgrade. More people would start skipping upgrades, and just wait until they actually needed the features of the new upgrade, if they would ever need it, and at some point, they won’t. Thus, Microsoft can maximize its profits not only by setting the right price, but also by adding minimal value to each upgrade, thereby allowing the upgrade cycle to be extended.

Example: This CNET review (original source: http://www.cnet.com/software/0-3923247-7-2154338.html?tag=st.sw.3709-8-2880332-1.more.2111110-7-2154338, no longer available) of Windows Millennium Edition, Microsoft's latest operating system, not only describes the upgrade as minor, but even points out that applications actually run slower on Windows ME than on Windows 98! Of course, aren't all Microsoft upgrades minor? If only the price was just as minor! You can always supplement Windows ME with some software by other companies. This CNET article (original source: http://www.cnet.com/software/0-3923247-8-5788833-4.html?tag=st.sw.3923247-8-5788833-1.subdir.3923247-8-5788833-4, no longer available) talks about some of that software. I wonder when Microsoft is going to bundle these applications into Windows? Maybe we'll have to wait until the end of this millennium!

Now what if Microsoft had competition? Then Microsoft would add as much value as possible to each upgrade and release it as soon as possible, so that it can sell more copies and lower its development costs per copy and therefore enjoy higher profits. Thus, Microsoft the competitor is the complete opposite of Microsoft the monopolist! Microsoft the competitor adds the most value to its customers; Microsoft the monopolist adds the least value. Which one is better for the public?

Software Bundling

Software bundling is problematic. While it is certainly desirable for the consumer to have more software bundled together, because supplementing Windows with other software is expensive, it also makes it difficult for competitors to compete, even if their product is vastly superior. Furthermore, bundling does have a legitimate business purpose, because bundling is one way that a software company can add more value to its product, and, as argued above, this will be necessary as software matures. However, lack of effective competition has allowed Microsoft to be discrete in its bundling, adding products where it wants to dominate, such as browsing software, or products that Microsoft thinks will help to sell more upgrades, such as Windows Movie Maker bundled with Windows ME. Otherwise, Microsoft provides the minimum value that it perceives will be effective in selling upgrades. That's why Internet Explorer is a great product, and thus, nobody buys a browser, but a big market still exists for Norton Utilities and other operating system utilities, much of it shareware.

The ideal competitive situation would have prevented this "innovation trickling." Lack of competition allows Microsoft to dollop improvements and features to extend the upgrade cycle. Only where Microsoft has real competition in areas where it clearly wants to be a leader does it deliver. One thing that could have, and still might, prevent this slow dolloping of improvements is Microsoft's diminishing sales unless it starts adding real value to its upgrades. I said could have because Microsoft wants to try to force people to pay it constantly through the use of subscriptions, thereby obviating any need to add significant value to its upgrades-or no value at all, if it so chooses. I said still might because I don't think Microsoft will be successful with subscriptions, unless they add real value for the money. But how can one know the value of a software subscription beforehand? According to a CNN article, subscriptions will be more expensive than buying upgrades. Without competition, the only factor that can impel Microsoft to add more value for the money is by people refraining from buying upgrades that have little value, or worse yet, that require subscriptions.

The Courts Need to Recognize that there are Different Methods of Predatory Pricing and Different Methods of Recoupment in the Software Industry

Because the essential elements of predatory pricing have been developed in case law long before the existence of a software industry, OEM distribution and bundling cannot be easily characterized as predatory pricing in the legal sense, because Microsoft is probably now getting paid for Office by the OEMs, and Microsoft does make a profit on bundled software, thus making prosecution of Microsoft uncertain under a predatory pricing cause of action. Moreover, because bundling has a legitimate business objective, it requires a rule-of-reason analysis. However, it is predatory pricing because (1) the customer is getting the software for no apparent charge; (2) it reduces competition, and (3) it allows Microsoft to keep prices far above competitive levels. The effectiveness of this strategy can easily be seen in the office-suite market, where the markets for WordPerfect Office and Lotus SmartSuite are mere vestiges of what they once were.

The reason why the Sherman Antitrust Acts were written in broad language was because it was difficult—indeed, impossible—to know beforehand what methods a business would use to gain and maintain a monopoly. Congress left the details to the courts and, eventually, to the Department of Justice and the Federal Trade Commission. What the courts, the DOJ, and the FTC need to recognize is that the software industry allows new variations on both predatory pricing and recoupment.

Software bundling is obviously a form of predatory pricing, because the consumer doesn't have to pay anything additional for the software. Note that this is not the same thing as not paying for it. As discussed above, the consumer is paying for it—just not separately. OEM distribution is another form of predatory pricing, even if Microsoft is getting paid for the software by the OEMs. The consumer is not paying additionally for it, or he doesn't realize that he is, and, therefore, this just as effectively locks out competition unfairly. This has the same effect as the traditional form of predatory pricing—that of giving the software away for free. In fact, OEM distribution is even better because the software is already installed and set up!

The software monopolist also has a new variation on recoupment of costs. As can be seen with Windows and IE, software bundling allows the recoupment of costs because the monopolist gets to maintain high upgrade prices by bundling more software. This isn't explicit recoupment, but it's recoupment, nonetheless. Adding IE to Windows allowed Microsoft to maintain its high upgrade price on Windows. Without additional software for Windows, Microsoft would have had to lower upgrade prices or accept fewer sales. This trend is continuing with the addition of Windows Movie Maker and Windows Media Player to Windows ME, the next upgrade of Windows for consumers. Thus, Microsoft not only gets to eliminate competitors, but it gets to recoup its costs in a subtle way that courts have yet to recognize!

While OEM distribution and software bundling are not strictly predatory pricing as developed in case law, they are anticompetitive, and thus, violate the Sherman Acts. Case law needs to encompass these anticompetitive acts peculiar to the software industry.

Not only can Microsoft recoup its costs, it can even raise prices without raising prices! Consider this hypothetical scenario: Microsoft spends $100 million for development to upgrade Windows 95 to Windows 98. Retail price of Windows 95 and Windows 98 is the same $209 for a full install. Now Microsoft spends $50 million dollars to upgrade Windows 98 to Windows ME, and charges the same price for Windows ME, $209. Thus, Microsoft receives more money for less cost of development, thereby raising its profits. The same effect could be achieved by spending the same for development and raising the price of its software, but Microsoft doesn’t want to raise prices which might raise the ire of customers who have come to expect technology prices to drop. Furthermore, while price increases are easy to see, it is very difficult to quantify improvements in the upgrades. Thus, it can clearly be seen in this situation how Microsoft can raise prices without raising prices—simply by spending less for improvements, then charging the same price for those improvements.

News Alert (August 1, 2000, original source: http://cnet.com/news/0-1006-200-2406026.html?tag=st.ne.1002.srchres.ni, no longer available): Microsoft has just reduced the price on Windows ME to $59 for owners of Windows 98 and Windows 98, Second Edition. It seems that Microsoft hasn't been selling enough retail upgrades of Windows 98—only 4,000,000 copies so far, according to PC Data. However, according to Microsoft (original source: http://www.microsoft.com/windowsme/news/promopricing.asp, still available but the page has been changed), this is a promotional price that will only last until January 15, 2001. $59 is still a supracompetitive price, but at least it's less than the $89 street price of Windows 95 and 98.

Average Total Cost

A company's total cost divided by its total output, equals the sum of average fixed and variable costs in the production of each item sold. Average total cost includes a normal profit. Market price=average total cost in long-run competitive and monopolistic competitive industries.

Monopolistic Competition

A market characterized by numerous sellers of slightly different products, and where entry and exit from the industry is easy.

Oligopoly

A market characterized by few sellers, a high barrier to entry, and mutual interdependence with its rivals. Mutual interdependence exists when one firm's decisions about prices affects other firms' decisions about their prices. Thus, an oligopolistic firm, when deciding at what price to sell its products, must consider the response of rivals. Although Microsoft might seem, in some cases, to be part of an oligopoly, it's not, because its competition is moribund, and thus, inconsequential. The natural barriers to competition are now so high and still increasing, that Microsoft is insulated from pricing pressure from its rivals.

Diseconomies of Scale

Factors relating to a company's large size that cause the average cost of production to increase. Most diseconomies of scale are caused by the difficulty of managing enormous enterprises, stretching facilities beyond their limit, and adding additional fixed costs.

Natural Monopoly

A market condition where one company, because of economies of scale, can produce the total market output at a lesser average cost than a plurality of companies could. Average total costs continually declines with increased output. Utilities were a classic example of natural monopolies, although technology is changing this to some extent. The government allows these monopolies because the company can provide the product at a lesser cost than if it had competition. To prevent abuses by the monopoly, the government regulates it, especially its prices, otherwise the monopoly would charge a higher price to maximize profits at the expense of the consumer.

Microsoft is a natural monopoly because the marginal cost of software is virtually zero. Since there are no diseconomies of scale in copying software, average total costs continuously declines with increased output, asymptotically approaching marginal cost, which, even with packaged software, is less than $5. Note that if Microsoft had real competition, software prices would be at average total cost, which, with Microsoft's huge sales volume, would be slightly more than $5! Of course, as a true monopoly, Microsoft can sell at many times that price, and does.

Microsoft is a Natural Monopoly

Microsoft has a great reason to establish and maintain a monopoly, if it could do so without true competition forcing it to reduce prices. Software is unlike any other business. Because the marginal cost of software is virtually zero (and in the case of OEM distribution and volume licensing (original source: http://www.microsoft.com/enterprise/licensing/Default.htm, no longer available), it actually is zero, since the licensee pays for any packaging and distribution), its average total cost continually declines with volume, and because expanding the number of software units only involves making copies, there are no diseconomies of scale and no necessity to increase fixed costs. Because marginal cost is so low, average total cost continually declines as it asymptotically approaches marginal cost, and unlike many other industries, average total cost never rises. Thus, Microsoft is a natural monopoly.

Sales figures and cost of development for software are hard to come by, especially with multiple versions and constant upgrades becoming available, but consider this. According to Microsoft (Microsoft Office Now Fastest-Selling Business Application Ever), Microsoft sold more than 20 million licenses of Microsoft Office 97 in less than a year, at the average of rate of 60,000 per day! Furthermore, Microsoft already had an installed base of 55 million for its desktop applications prior to the release of Office 97 (Microsoft Office 97 Released to Manufacturing). With the number of computer users still growing rapidly during the late 90's, it certainly is not unreasonable to assume that Microsoft sold at least 50 million copies of Office 97 in the 2 ½ years between its initial release on November 19, 1996 and the release of Office 2000 on June 10, 1999. (An average rate of 60,000 copies per day for 933 days yields 55,980,000 copies, so 50,000,000 is a conservative number.) Let's further assume that Microsoft received an average of $200 per copy, not an unreasonable figure considering that MS Office prices ranged from a little over $200 to over $400 for an upgrade, depending on version, and almost double that for a full version. Let's further assume that it cost Microsoft $50 million dollars to develop Office 97. Again, not unreasonable when you consider that Office 97 was an upgrade to Office 95, so it wasn't like they were creating the software from scratch. The cost could be considerably less than this, because, (1) as I have already argued, Microsoft's goal is to add as little value as possible to each upgrade; and (2) much of the code between programs is shared, thus reducing costs even more. Multiplying price per copy by the number of copies sold yields a staggering $10 billion in revenues. (It has recently been reported that Microsoft receives 40% of its revenue from Office; thus, that's almost $10 billion in ONE YEAR!) Subtract the cost of development and the cost of packaging yields $9.7 BILLION in profit! That's a staggering profit margin of 97%! The profit earned per unit sold is more than 33 times what the unit cost! Of course, Microsoft as a company doesn't earn this much profit or have a margin this high, because it is diluted by fixed costs, administrative and marketing expenses, and the company's other, less profitable, endeavors and other monopolizing efforts, but, nonetheless, its profit margin as a whole for 1999 was 39.4%, far higher than most other companies. In the last 5 years, Microsoft's profit margin has increased from 24.5% in 1995 to 39.4% in 1999 (http://www.stockselector.com/earnings.asp?symbol=MSFT&ref=344, page still available but info has changed), and this trend will only continue as Microsoft sells more software to a wider, worldwide market, simply because the marginal cost of software is very little, so the average total cost of each unit continually declines! (Compare Microsoft's profit margin and growth to super-efficient Dell Computer(page still available, but displayed info reflects latest data), which has an average profit margin of less the 8.5%!)

News Alert (original source: http://www.microsoft.com/msft/earnings/earnq400/earnq400.htm, no longer available): The trend continues! Microsoft has announced earnings for the fiscal year ending June 30, 2000. Net income was $9.42 billion from revenues of $22.96 billion. That's a profit margin of 41%! Profit margin continues to climb as Microsoft's average total cost, as a natural monopoly, continues to decline (even with litigation expenses) while still maintaining high prices for consumers. Note that this is NOT gross profit margin, but NET PROFIT MARGIN - after taxes have already been paid! This is the single best evidence that Microsoft is a monopoly charging exorbitant prices to consumers!

High Consumer Prices + Falling Average Total Costs = Greater Profits

Let's consider a different scenario, a much better one for consumers. Suppose Microsoft got only $20 per copy of Office, instead of $200. Using the same figures above, this would yield revenues of $1 billion, profits of $450 million, and a profit margin of 45%—still pretty hefty! Of course, if Microsoft were selling Office wholesale for $20 per copy, then, in today's competitive retail market, Office would be selling for under $30 instead of $225 to $400 or more for an upgrade! And as the user base expands, as it surely will, Microsoft software could come down even more! Microsoft has already reported that sales for Office 2000 are 31% ahead of Office 97 for a comparable period.

As a natural monopoly, Microsoft's costs keep falling, but Microsoft doesn't want to pass the savings on to customers, which is why its profit margin is so large and continually increases, at least for software! Consider this: One reason why Dell Computer was so profitable as a computer manufacturer was because when component prices dropped, Dell Computer didn't drop their prices right away. Thus, Dell earned a higher profit. Of course, Dell Computer couldn't do this indefinitely, because it has real competition. If Dell didn't lower prices at some point, it would lose market share to Gateway and other competitors as they lowered their prices. But now imagine that Dell had no or nominal competitors. It could maintain its prices even as components costs were dropping dramatically. Thus, it would earn a much higher profit that would continually increase as component costs dropped. With Microsoft, this is the actual situation. Its costs have dropped dramatically and continue to do so, but it doesn't want to pass the savings to customers! It doesn't have to, because it has pricing power, the true sign of a monopoly. It wants to keep the extra money as profit!

It is the continual decline in average total cost of software that makes Microsoft a natural monopoly. True competition would have forced Microsoft to reduce its prices, but, because it eliminated the competition though anticompetitive means, it didn't need to respond to competitors' prices. In fact, Microsoft has increased prices for its operating systems, and it wants to negate any attempts to lower those prices (OEM Pricing Thoughts - a Microsoft confidential memo). Not only does Microsoft not want to compete with anyone else on prices, it doesn't even want to compete with itself! That's why Microsoft raised the price of Windows 95 to OEMs when it released Windows 98, because Microsoft didn't want customers choosing the cheaper Windows 95.

True Competition Would Have Lowered Software Prices to Average Total Costs and Eliminated Any Differences Between Full and Upgrade Prices

So how can the consumer ever be sure of getting the best value for his money? By buying from a competitive industry. In a truly competitive software world, each company would continually produce better software products at lower prices to increase sales, thereby allowing them to lower prices further to try to gain greater market share. As sales volume increases, research and development costs per unit of software would decline to low levels. Average total cost would approach marginal cost, allowing competitive firms to charge very low prices, and still make a profit. Eventually, in a natural monopoly industry, a monopolist would arise, even with true competition, but the monopolist wouldn't be able to raise prices after its competitors are gone, because, by then, after years of competition and development, the current software would satisfy the needs of most people, and if the monopolist raised prices, most people just wouldn't buy the upgrade, and unlike most products that are manufactured, such as computers, software doesn't break. As long as people have adequate backup plans, the software will last as long as people do.

As software companies would have strived to increase their market share, they would have also eliminated the price differential between upgrades and full editions, because companies that lowered prices as much as possible, especially to new customers, would benefit from greater sales volumes and the ability to lower prices even more. This scenario befits a natural monopoly industry, but Microsoft has prevented this by using anticompetitive practices to thwart competition.

Microsoft has recouped its costs in its early editions of its software years ago. There is no reason why Microsoft should continue charging full price to new customers that don't have either Microsoft products, or competitor's products that would qualify for a Microsoft upgrade. After all, computer prices are the same for everyone, whether they owned a computer before or not. The same should be true for software, but here again, the lack of competition lets Microsoft charge the much higher price.

If anybody has any doubts that competition truly helps to lower prices, just look at Microsoft's pricing of Windows CE. Windows CE is the Windows for handheld computers, informational appliances, and embedded devices. Because these devices are much more limited in capabilities and are built for specific purposes, the consumer doesn't care as much about the underlying operating system. This gives Linux and other free operating systems a big advantage, because the cost of the hardware is much less than for a PC, and cost will be a major factor in how well these devices sell. Manufacturers that can cut costs will have an advantage, and one way to do that is to use a free operating system. Microsoft currently charges about $10 to $15 per Windows CE license to undercut its main competitor in handheld computers, the Palm, which charges about $20 for its OS. However, Microsoft may have to go even lower as major manufacturers, including Microsoft's own desktop allies such as Compaq and Hewlett-Packard, are developing handheld prototypes using Linux. Microsoft may have to give Windows CE away for free just to meet the competition, and, according to this report (original source: http://www.zdnet.com/zdnn/stories/news/0,4586,2468874,00.html, no longer available), it's contemplating just that. What else can it do? It can't get rid of Linux, since Linux is already free. Competition works! More choices and much lower prices.

Microsoft Uses Windows to Stifle DOS Competition

From Caldera vs. Microsoft

CONSOLIDATED STATEMENT OF FACTS IN SUPPORT OF ITS RESPONSES TO MOTIONS FOR SUMMARY JUDGMENT BY MICROSOFT CORPORATION

54. Gates began thinking about how to protect Microsoft's DOS monopoly, with particular emphasis on the emerging power of its Windows graphical user interface. On May 18, 1989, Gates sent a memo to his executive staff specifically addressing "Operating Systems Strategy," and specifically noted his concern about falling revenue:

The DOS gold mine is shrinking and our costs are soaring — primarily due to low prices, IBM share and DR-DOS. Making Windows a strong product benefits our gold mine and protects it in the following ways:

DR DOS. I doubt they will be able to clone Windows. It is very difficult to do technically, we have made it a moving target and we have some visual copyright and patent protection. I believe people underestimate the impact DR-DOS has had on us in terms of pricing.

Price Competition amongst the PC Manufacturers Benefited Microsoft by Expanding its Market and Eliminating Apple Computer as a Real Threat

Ironically, it was price competition among the computer manufacturers that have helped Microsoft to greatly increase sales, because software is worthless without computers to run them. Software and computers are complementary products. Therefore, as computer prices dropped, computer sales increased greatly, increasing Microsoft's sales proportionately. But Microsoft doesn't want to benefit the consumer by lowering its own prices, and this is why Microsoft software now accounts for a larger percentage of the cost of a computer system.

Price competition among the computer manufacturers had another beneficial effect for Microsoft—it eliminated Apple Computer as a real competitor! In earlier years, the Apple Macintosh computer was widely regarded to be superior to the IBM compatible computers, and the Mac OS was considered much better than Windows. (Some people consider this to be true even today!) In fact, the mere existence of Windows was due, in large part, to the success of the Mac OS, from which Microsoft copied heavily. So why didn't Apple succeed? Because it wanted to be a monopoly, and strove hard for those monopoly profits, and subsequently, it charged high prices before it really had a lock on the market. Apple was very successful in the educational market because it charged much lower prices to schools and students, and, thus, gained the lion's share of the educational computer market. Apple hoped to recoup its costs later, after the students graduated and upgraded their machines. Unfortunately for Apple, Apple didn't extend the price cuts beyond the educational market. Apple's prices for everyone else were much higher, allowing the IBM compatibles to capture most of the market share, and this, in turn, generated much more revenue for Microsoft. With the rest of the world embracing IBM compatibles, eventually, even the schools had to follow suit. Otherwise, students would be learning one system in school, only to find, after graduation, another system in the business world.

Apple was also unwilling to market its OS to the IBM world, because Apple recognized that one of the biggest assets of the Macintosh was the operating system. Had Apple developed its OS for the IBM compatibles, this could well have been Apple's greatest cash cow, and Apple probably could have sold more of its own computers. It might have supplanted Microsoft as the dominant OS provider and standard setter. But, alas, Apple, too, wanted to play monopoly—but it lost.

Microsoft Could End Most Piracy of its Software by Charging Reasonable Prices

Microsoft is constantly complaining about and prosecuting software pirates. Although Microsoft claims (Piracy Facts and Figures, original source: http://www.microsoft.com/piracy/basics/facts_figures.asp, no longer available) that piracy causes loss of jobs, wages, and tax revenues, this isn't the true picture, because they don't account for how the saved money is spent elsewhere. If I had spent $30 for MS Office instead of $430, then that's $400 that I could have spent elsewhere, thus generating jobs and wages for those other businesses that I patronized and tax revenues for governments.

Ironically, Microsoft limits jobs in the software industry. Because a monopoly restricts output to maintain high prices, it uses less of each factor of production, which includes labor. Additionally, because Microsoft wants to upgrade its software as slowly as possible to extend the upgrade cycle, this lessens the demand for labor even more. And because competitors are selling less of their products as Microsoft expands its monopoly, this, too, reduces the demand for labor by the competitors. Thus, total employment in the software industry is less than it would be in a competitive industry.

Software pirates are Microsoft's true main competitors, and they make it hard for Microsoft to maintain high prices on its software. This is why Microsoft coerced OEMs, through discriminatory pricing, to agree on per-processor licenses. Microsoft received payment on all computer systems shipped, whether those systems had Microsoft software or not. Microsoft ostensibly argued that this would deter piracy since people wouldn't buy pirated software if their computer already came with the operating system. Of course, this policy also locked out competing operating systems, and forced many customers to pay for the same operating system more than once. So not only does Microsoft get to maintain high prices with this policy, it also thwarts both pirates and competition!

Allocative Efficiency

The production of the most desirable goods in the desired quantities.

Now that Microsoft is prohibited from stipulating a per processor license in its contracts, pirates will be more effective in keeping Microsoft's prices lower by providing more competition with Microsoft. Thus, pirates serve a public interest by lessening Microsoft's price gouging of its victims "customers". This is an important public benefit, because there is a fundamental difference between pirates stealing from Microsoft and Microsoft stealing from its customers by charging high prices. When a pirate sells copies of Microsoft software, it merely deprives Microsoft of some potential revenue, and most sales of pirated software would not have been revenue for Microsoft, anyway, because pirates sell at a lower price (typically, $5 to $20), which allows many more people to buy the software. Most of those people would not have paid Microsoft's much higher price, even if there were no pirated copies to buy. This follows from price elasticity—the lesser the price, the greater the sales volume. Thus, pirates also increase allocative efficiency, another great benefit to society. However, when Microsoft steals from its customers, Microsoft is arrogating real money from buyers of legitimate software, money that most buyers had to work for, and pay taxes on.

Ironically, the only reason pirates can even exist is because Microsoft wants to maintain high prices. Because Microsoft is a natural monopoly and because it has the greatest economies of scale for packaging and delivering its software, and with development costs at pennies per unit of software, it could end most piracy of its software, wherever it is found, simply by lowering the price of its software to slightly above marginal cost, as they would have had to if they had true competition. Pirates would not be able to compete against such low prices, because pirates are very small, isolated distributors, who have additional costs besides lower efficiency, such as evading the law. This is especially true if Microsoft offered electronic delivery of all of its software over the Internet, and it is certainly true in volume-licensing deals that Microsoft provides for businesses and organizations, because in both cases, the marginal cost is zero, thus, prices could easily be less than $10 per unit. Because of Microsoft's sales volume, such low prices could still cover the cost of development and marketing, and still provide Microsoft with a reasonable return of its investment. Sales would skyrocket, even without marketing, giving Microsoft an even greater efficiency. But, alas, Microsoft doesn't want to do this. Microsoft wants to maintain its status as the largest software pirate in the world—a pirate that steals money from people through its high software prices!

As a Monopolist, Microsoft's Best Strategy is NOT to Innovate!

Bill Gates (before the Committee on the Judiciary, United States Senate, March 3, 1998): "A software product is the copyrighted expression in lines of code of ideas. No one can monopolize new ideas that can be implemented in software." (Original source: http://www.corpwatch.org/trac/feature/microsoft/monopoly/gates.html, no longer available.)

Microsoft repeatedly says that it should be free to innovate. It even has a separate website called the Freedom to Innovate Network (original source: http://www.microsoft.com/FREEDOMTOINNOVATE/default.htm, no longer available). This is ironic, because Microsoft has never been known as an innovator. And, yet, this is perplexing. How is it that a company with so much wealth and resources at its disposal innovates so little? Because it is more cost-effective to see what sells, then either copy the idea or simply buy the technology outright. Sometimes, Microsoft invests in a company only to learn its secrets, then divests itself of the company to make its own product, as it did with RealNetworks. Although software code is copyrightable, software ideas are not, as Gates himself noted in Congressional testimony, quoted above. So why risk money developing products that nobody may want (like Microsoft's Bob!), when, as a monopolist, Microsoft can just observe the market to see what sells. Microsoft doesn't have to be the first in anything, which is why it isn't. With its installed base, and proven techniques of creating and maintaining a monopoly, Microsoft can take any market it wants, after it has been proven profitable. Only when Microsoft feels sufficiently threatened, as it did with Netscape, does it work hard to produce a better quality product. Otherwise, Microsoft is, in Bill Gate's own characterization, "a lazy monopolist," always attempting to give the least value for the most money.

The Start of Microsoft "Innovation" - Early Days of Digital Research Inc. and Microsoft Corp.

From Caldera vs Microsoft

CONSOLIDATED STATEMENT OF FACTS IN SUPPORT OF ITS RESPONSES TO MOTIONS FOR SUMMARY JUDGMENT BY MICROSOFT CORPORATION

3. Digital Research, Inc. was founded in 1976 to pioneer the development of operating systems suitable for use on microprocessors (the central processing unit, or CPU) of what are today known as personal computers. DRI's founder and chairman, Gary Kildall, held a Ph.D. in Computer Science. In 1973 he developed a program called CP/M (Control Program for Microprocessors), which was one of the first operating system programs for personal computers. Williams Decl. at 3; see generally Exhibit 4 at 11-12 (History of the Microcomputer Revolution); Exhibit 5 (Chronology of Events in the History of Microcomputers).

4. CP/M quickly became the dominant operating system in the market for 8-bit personal computers in the late 1970s and early 1980s. (See D. Ichbiah, The Making of Microsoft at 50-52.) During this time DRI enhanced CP/M to optimize its capabilities for 8-bit microprocessors and created a family of CP/M based operating systems. Driven by the strength of CP/M products, DRI's revenues grew to over $54 million in 1984. Williams Decl. at 3; see Exhibit 13 (DRI Business Plan, August 1987).

5. Bill Gates and Paul Allen were intrigued by the Popular Electronics issue announcing the Altair 8800. They wrote MITS that they had a version of BASIC (a programming language) written and ready to run. No such code existed, but when MITS expressed interest, Gates borrowed from and quickly adapted DEC's RSTS-11 BASIC-PLUS. (Gates at 70-71.) MITS bought it. In short order, Gates dropped out of Harvard; he and Allen moved to Albuquerque; and by mid-1975, they formed Microsoft as a partnership. Id. at 82-84; Exhibit 5 (Chronology of Events in the History of Microcomputers).

6. Microsoft's initial focus was on programming languages, which required an underlying, compatible operating system. Microsoft chose the emerging standard, CP/M. (The Making of Microsoft at 52.) Gates visited Kildall in November 1977, and obtained a license for $50,000 cash. (Gates at 120, 138.)

7. In July 1980, IBM contacted Microsoft about IBM's undisclosed plans for a personal computer, and asked Microsoft to design compatible 16-bit versions of its most popular products: BASIC, COBOL, FORTRAN, Pascal and the BASIC compiler. (Gates at 151-154.) But IBM still needed an operating system. DRI was already planning a 16-bit version of CP/M, called CP/M-86. Microsoft had obtained a preliminary version, but had no right to sub-license. (Id. at 154.) Gates told IBM to contact Kildall. Exhibit 4 at 15 (History of the Microcomputer Revolution). IBM and DRI were unable to agree on terms for a CP/M license. Exhibit 330 (Kildall 11/13/92 letter).

8. Microsoft moved quickly to "design" an operating system for IBM. Tim Paterson, an engineer at a small Seattle-based OEM named Seattle Computer Products, had already designed in April 1980 his own 16-bit CP/M "clone," i.e., it mirrored CP/M's function calls. He dubbed it QDOS -- Quick and Dirty Operating System. On January 6, 1981, Microsoft licensed QDOS (subsequently dubbed "86-DOS") for $25,000 -- while obtaining a right to sub-license, and without disclosure of IBM's interest. Exhibit 6 (License Agreement). Just prior to launch of the IBM PC in August 1981, Microsoft decided to buy the product outright. On July 27, 1981, Microsoft paid an additional $50,000 to Seattle Computer. Exhibit 7. Microsoft had its DOS, without any original work of its own, for a total price of $75,000.

9. Microsoft gave IBM a royalty-free license, but retained ownership rights to this DOS, which it planned to license to the clone OEM vendors sure to follow the IBM standard. See Exhibit 29. When the IBM PC launched in August 1981, two identical operating systems emerged: IBM offered PC-DOS 1.0 to its customers; Microsoft offered MS-DOS 1.0 to all other OEMs and their customers. Exhibit 12 at MSC00566789, -873) (Paterson interview transcripts); Exhibit 8 (Softalk for the IBM Personal Computer, March 1983, "Tim Paterson: The Roots of DOS").

10. Years later, Kildall's obituary summed up these events succinctly:

Unable to agree to a deal, IBM turned to another small company, Microsoft, for what turned out initially to be a copycat product. Kildall was livid. He said: "Here we were, in good faith, in negotiations with IBM and they came in with a complete rip-off."

Microsoft Clones DRI's CP/M

11. The links from CP/M to QDOS to MS-DOS 1.0 are well-recognized. See Ivie Report at 34-36. Kildall noted that DOS "mirrored the 'de-facto industry standard' CP/M interface." Exhibit 330 (Kildall letter). The technical treatise Undocumented DOS provides a brief overview, and points to other works mapping the extensive similarities between CP/M and MS-DOS:

MS-DOS's large-scale borrowing from CP/M is not disputed. As Tim Paterson would write somewhat later in "An Inside Look at MS-DOS" (Byte, June 1983), "The primary design requirement of MS-DOS was CP/M-80 translation compatibility."

12. Microsoft's own programmers have readily acknowledged what was done. Only two people at Microsoft worked on MS-DOS 1.0. Reynolds Depo. at 8. One of them, Chris Peters, later testified when Seattle Computer Products sued Microsoft concerning the purchase of QDOS:

Again, from the programmer's point of view, MS-DOS 1.0 was primarily a clone of CP/M.

Another Example of Microsoft "Innovation" - Microsoft Uses Monopoly Power to Threaten Stac to Turn Over its Proprietary Technology for Nothing!

6. MS-DOS is currently installed on in excess of 100 million IBM and IBM-compatible personal computers, and Microsoft ships more than 20 million units of MS-DOS every year. Microsoft's MS-DOS is the predominant operating system in the IBM and IBM-compatible personal computer market. MS-DOS is marketed principally to original equipment manufacturers (OEMs) under agreements that allow the OEMs to distribute the MS-DOS operating system software with their personal computers.

7. Stac is the manufacturer and publisher of a data compression utility program known as STACKER, which attaches to DOS operating systems such as MS-DOS, as well as other operating systems. Utility programs are a large and diverse family of application programs that are designed to enhance personal computer performance. The principal function of STACKER is to compress data stored on the hard disk of IBM and IBM-compatible personal computers when the data is not being used, and later decompress such data when it is to be used, thereby increasing the effective storage capacity of the computer.

8. Although there are a number of software companies which offer data compression programs, Stac is the acknowledged industry leader in developing and marketing data compression technology, and STACKER is currently the best-selling data compression program for use on the DOS operating system. Stac's proprietary data compression technology, developed over the course of five years and at substantial cost, is protected by a number of patents, including U.S. Patent Nos. 5,016,009 (the "009" patent) and 4,701,745 (the "745" patent) (collectively, the "patents in suit").

10. Largely as a result of the tremendous market acceptance of STACKER, which utilizes Stac's proprietary data compression technology, Stac quickly grew from a company with 25 employees and revenues of less than $1 million in 1989 to a company with more than 200 employees and a market capitalization in excess of $150 million today.

11. The personal computer software industry is characterized by rapid technological change which requires software developers continually to enhance existing products and develop new products. A critical factor in the success of a new or enhanced product is getting the product to market quickly in response to new user needs or technological advances, while at the same time maintaining the integrity and quality of the product.

12. It was a well-known fact in the personal computer industry as early as 1991 that Microsoft's MS-DOS 5.0 retail upgrade sales were rapidly declining with each passing quarter. As Microsoft's flagship product -- with approximately $700 million in revenue per year attributable to MS-DOS sales alone -- Microsoft was under intense market pressure to stimulate MS-DOS sales with an improved version of the MS-DOS operating system.

13. Due in part to the overwhelming market success of STACKER, the personal computer industry quickly recognized that an operating system capable of incorporating a high-quality data compression utility such as STACKER would be highly competitive. Indeed, the principal competitor of Microsoft's MS-DOS -- Novell's DR-DOS operating system -- had already incorporated a data compression utility in its operating system software.

14. Microsoft's Chairman and Chief Executive Officer, William H. Gates, became personally interested in Stac's proprietary data compression technology, and the possibility of using such technology in MS-DOS, in 1991, at approximately the same time that STACKER was receiving a number of coveted industry awards for technical excellence and overall product quality.

15. Mr. Gates met with Stac's President, Gary W. Clow, at the Fall Comdex-91 ceremony in Las Vegas. During a discussion which preceded the award ceremony, Mr. Gates said that Microsoft was considering including a data compression capability in the next release of MS-DOS. Mr. Gates further stated that Microsoft would not be developing this capability internally, but rather would seek to obtain another company's data compression technology for inclusion in MS-DOS. The Editor-in-Chief of PC Magazine, Michael J. Miller -- whose magazine would later that evening present its Technical Excellence Award to Stac -- told Mr. Gates before the ceremony began that STACKER was a first-rate product. Mr. Gates asked Mr. Clow to contact Microsoft after Mr. Clow returned to California, and Mr. Clow agreed.

16. In late 1991, as a result of Mr. Gates' interest, Mr. Brad Chase -- who was then Microsoft's Group Product Manager and who today is Microsoft's General Manager for MS-DOS -- and Mr. Clow began discussing the possibility of Microsoft licensing Stac's proprietary data compression technology for inclusion in future versions of the MS-DOS operating system.

17. During the ensuing months of negotiations, Microsoft proposed that Stac grant to Microsoft a world-wide license to incorporate STACKER data compression technology and know-how into future versions of its MS-DOS operating system software. Microsoft steadfastly refused, however, to offer to pay Stac any royalty for Stac's patented data compression technology.

18. Mr. Chase made it clear during the negotiations that Microsoft was considering including data compression capability in future versions of the MS-DOS operating system, and that if it were unable to reach an agreement with Stac, it would obtain this capability elsewhere, even though Microsoft believed -- as it told Stac on numerous occasions -- that STACKER was the best data compression product for the DOS market. When the subject of incorporating data compression technology other than Stac's arose, Mr. Clow reminded Mr. Chase and others that Stac owned patent rights to its data compression technology and would enforce its patents against any infringers. At least one draft agreement was provided to Microsoft that included a specific reference to Stac's '009 patent.

19. Microsoft attempted to persuade Stac that its proposal to incorporate Stac's proprietary data compression technology -- or, for that matter, any reliable data compression technology -- into the MS-DOS operating system would, if implemented, have an immediate and adverse effect on the viability of STACKER as an independently marketed product for the DOS market. Indeed, at one point during the negotiations, Microsoft presented Stac with a spreadsheet analysis purporting to detail the adverse impact on sales of STACKER -- Stac's flagship product -- in the event Microsoft and Stac failed to reach an agreement and Microsoft incorporated a different data compression utility in future versions of the MS-DOS operating system. <- Boldface emphasis here is mine. Even by 1992, Microsoft clearly knew that it was a monopoly, and, as can be clearly seen here, is threatening Stac with its monopolistic control of the market to cede its technologies to Microsoft for nothing! Do you think a competitor can just go to a company and demand free technology? Is Microsoft morally better than a software pirate? Only a monopolist would think that it could get away with such an outrageous act. Since Microsoft expected to force Stac to give its technology to Microsoft for free, maybe the DOJ should force Microsoft to give Windows and Office to consumers for free!

20. In approximately April of 1992, Stac broke off further discussions with Microsoft in light of Microsoft's failure to present a proposal that offered reasonable compensation to Stac for Microsoft's use of Stac's proprietary data compression technology.

21. In approximately June of 1992, Mr. Chase advised Mr. Clow that Microsoft was obtaining data compression technology for use in MS-DOS, but that Microsoft wanted to offer Stac one last chance to reach an agreement. In the ensuing discussions, it again became clear that Microsoft had no intention of paying any compensation to Stac in exchange for Stac's proprietary data compression technology. Discussions between Stac and Microsoft thereupon terminated for the second time.

22. Shortly thereafter, it became well known to the industry that a new version of its DOS operating system, MS-DOS version 6.0 ("MS-DOS 6.0"), would be released in the first six months of 1993 and that MS-DOS 6.0 would include a data compression utility, which Microsoft was to later call "DoubleSpace."

23. Before a new program (or new version of an existing program) is made available for retail distribution, the software developer will often distribute preliminary copies of the new software (the "beta software'') to a large group of intended users (the "beta sites"). The developer then seeks comments from the beta sites on the beta software's performance, thereby allowing it to identify and fix problems or "bugs'' in the beta software that might have slipped through the developer's quality control procedures. Consistent with this practice, Microsoft commenced its MS-DOS 6.0 Beta Test Program in the second half of 1992.

24. On or about November 23, 1992, a telephone conference was held with Mr. Clow and Mr. Whiting of Stac, and Microsoft's Mr. Chase. During that conversation, Mr. Chase admitted that, during Microsoft's "normal due diligence process,'' Microsoft had concluded that the DoubleSpace data compression utility of the MS-DOS 6.0 operating system software infringed Stac's '009 patent, one of the two patents in suit. Mr. Chase requested that Stac grant a license to Microsoft under Stac's '009 patent. After a brief discussion, Mr. Clow requested that Microsoft make a specific licensing proposal to Stac, and Mr. Chase agreed to do so. During this same telephone conference, Mr. Chase promised, in response to Stac's request, to make available to Stac a copy of the beta version of the MS-DOS 6.0 software.

25. Several weeks later, after not hearing back from Mr. Chase on a licensing proposal for Stac's patent, and after not receiving the promised beta version of MS-DOS 6.0, Mr. Clow wrote to Mr. Chase and again requested a copy of the MS-DOS 6.0 software. Mr. Clow explained that other software developers had access to the beta versions of MS-DOS 6.0, which was putting Stac at a competitive disadvantage. Mr. Clow also noted that Stac was still awaiting a specific licensing proposal from Microsoft for Stac's '009 patent.

26. Microsoft finally made the beta version of the MS-DOS 6.0 software available to Stac in January of 1993. At or about the same time, with respect to Microsoft's earlier admission regarding the infringement of Stac's '009 patent, Mr. Chase advised Stac in writing: "Don't worry about the patent stuff. We are just going to keep with our changed code which does not infringe.''

27. After receiving the beta version of MS-DOS 6.0, Stac engineers determined that, whether or not the "code'' had in fact been changed from earlier versions, as represented by Mr. Chase, the DoubleSpace data compression utility contained in the beta version of MS-DOS 6.0 infringes upon Stac's '009 and '745 patents.

28. On or about January 15, 1993, Mr. Chase of Microsoft provided Mr. Whiting and Mr. Clow of Stac with a preliminary press release for the Microsoft Real-time Compression Interface ("MRCI''). MRCI defines a compression standard for allowing vendors to design software and hardware products that utilize or "build'' upon the Double Space data compression utility in the MS-DOS 6.0 operating system.

29. Microsoft's preliminary press release confirms that "DoubleSpace, the integrated data compression technology ... will be available with the next major version of MS-DOS, MS-DOS 6.'' The preliminary press release also reveals that, in an effort to have the compression technology in MS-DOS 6.0 quickly adopted as an industry standard, Microsoft is now offering to license - for free - the infringing DoubleSpace technology to independent hardware and software vendors. <- Another example of predatory pricing!

30. Mr. Chase sent Microsoft's preliminary press release to Mr. Whiting and Mr. Clow for the stated purpose of having Stac approve the following proposed quote for Microsoft's ultimate press release, drafted for Stac by Microsoft:

"We're excited about MS-DOS 6 and DoubleSpace because they create a large opportunity for boards, chips and add-on software to enhance the compression services that MS-DOS 6 and DoubleSpace offer ..."

31. On information and belief, Microsoft is taking the calculated risk of incorporating what it knows to be Stac's patented data compression technology in its MS-DOS 6.0 operating system in order to stimulate sales of its flagship product and respond to the intense market and financial community pressure to remain competitive and demonstrate continued growth.

A jury awarded Stac $120 million. Compare this with Microsoft's dealings with Intuit. A clear pattern of behavior can be discerned. Microsoft is clearly NOT an innovator; it doesn't have to be. It's a monopoly.

Microsoft also Causes Allocative Inefficiency, and Redistributes the Wealth from Poorer to Richer People

Microsoft causes allocative inefficiency in two ways:

Microsoft deprives poor, honest people of valuable products and the benefits of those products, such as better jobs and better lives.

Microsoft, because of its tendency to supply the least amount of improvement to its software for each upgrade, to lengthen the lucrative upgrade cycle, deprives people of better quality software and better features than they would have had in a competitive world, and those same people work less productively. The amount of work that could have been accomplished by people had they had better software sooner is incalculable, and underscores the need for competition.

Microsoft, like all monopolies, redistributes the wealth from poorer people to richer people. This is especially true in other countries where people are much poorer than Americans and where Microsoft's prices are even higher. You might call this the "anti-Robin Hood effect."

Refuting Arguments in Support of Microsoft

With a clear understanding of what Microsoft is doing, let's examine arguments advanced in favor of Microsoft.

Argument: If Microsoft is a monopoly, why doesn't it charge a lot more for Windows?

Answer: Microsoft has no real competition in operating systems for the PC. It is also keenly aware of antitrust laws, and that many people view Microsoft as a monopoly simply because of its dominance in PC operating systems. If Microsoft charged a much higher price, it would invite greater antitrust scrutiny, and greater public disapproval. It would provide strong evidence that Microsoft is, indeed, a monopoly. Furthermore, OEMs would really balk at higher prices for Windows, since they were required by Microsoft to ship the operating system with every system they sold to obtain the lowest prices for Windows. Higher prices for Windows would mean higher prices for PC systems, and fewer sales, both for Microsoft and the PC manufacturers. Thus, there would be a real danger that the OEMs themselves would have filed antitrust lawsuits against Microsoft. Microsoft felt it could charge much higher prices for its other products, such as Office, because it, at least, has nominal competition in those areas—nominal because its not enough to force Microsoft to lower prices, but enough so that it at least seems that Microsoft has competition. This is a big reason why Microsoft has invested in both Apple Computer and Corel, to prevent them from going bankrupt, so that at least a semblance of competition can be maintained.

Besides, Microsoft didn't have to charge higher prices for Windows. It got high prices anyway, because the amount that each new Windows version was improved was minimal, thereby obtaining a high price per improvement without anyone really noticing. Isn't this the better way to do it? To be able to charge high prices without anyone noticing? When buying upgrades, the price itself doesn't tell the whole story. The price has to be compared to how much better the upgrade is, and in the case of DOS and Windows, the difference between versions has always been minimal. This is how Microsoft has gotten the most bucks for the least bang, with very few people complaining. Indeed, Microsoft has duped the public so well, that Microsoft is consistently in the top 5 of Forbe's list of most admired companies.

Argument: Software prices have declined in every market that Microsoft entered, and plenty of software, such as AutoCAD, is much more expensive.

Refutation: Many people think Microsoft's prices are reasonable, because software prices have always been fairly high. However, Microsoft usually only enters mass markets, or what will become mass markets, because that is where the real money is. That is where a natural monopoly can reduce its costs significantly. On the other hand, niche markets, because of their much lesser sales volume, have to cover their costs of research, development, and marketing by charging higher prices. Their average total cost is much higher than it is for a mass market, such as operating systems and office suites. This is also why software was much more expensive in the early years of the PC. Lesser sales volumes means higher average total costs, which necessitates higher prices. However, once sales volumes increase, then, in a truly competitive world, prices should drop commensurately. That this hasn't happened with Microsoft's products only shows without doubt that Microsoft is a monopoly, earning monopoly profits by charging monopoly prices.

Argument: Competitors are merely using the law to compete unfairly. Some have even suggested that antitrust laws should be abolished entirely, because businesses use these laws to subdue competition.

Refutation: Not true for the operating systems; their prices have steadily risen. Windows 2000 is the most expensive Microsoft operating system ever. However, even in the case of Office, where prices have declined somewhat due to declining marginal utility of upgrades, prices aren't nearly as low as they could be. The question here is not "Have Microsoft's prices declined?" The question is whether they have declined to the same level that they would have had if Microsoft had true competition. Clearly, they have not, since this price would only be slightly higher than marginal cost.

Argument: Predatory pricing of software is impossible because competition drives costs to slightly above marginal cost, and since the marginal cost of software is nil, it's impossible to price below cost. According to this Salon article (no longer available), Microsoft was arguing that since the marginal cost of Internet Explorer is practically zero, it can't be guilty of predation, since it was just "selling" IE at marginal cost.

Refutation: I love this argument. It merely reinforces what I have been saying all along. What Microsoft has conveniently left out of this argument is the fact that the marginal cost of ALL software is nil, because the marginal cost of software is just the packaging and distribution, and, of course, if it is distributed by the Internet or by licensing, then it truly is zero. So that means that Office 2000 Premium Edition, Windows 2000, SQL Server 7.0 and every other software Microsoft sells should be the same price as IE—zero! Obviously, Microsoft wants to make something. The only reason Microsoft is pricing IE at zero and not its other software is because it wants to monopolize the browser market, and its merely advancing that predatory pricing is a myth in the hopes of being able to get away with it. Two final questions concerning this ridiculous argument. If the marginal cost of software is virtually zero, then why is Microsoft selling us the software for hundreds of dollars? And if true competition forces companies to sell at near marginal cost, and Microsoft is selling well above that, isn't that clear evidence that Microsoft has no real competition, and therefore has pricing power, and therefore is a monopoly?

Argument: "The Judge says charging a zero price for Internet Explorer was 'predatory' (too cheap). Never mind that Sun gives away the entire Star Office Suite and/or the Solaris operating system for Intel machines, that K-Mart and others give away free Internet services, or that many vital programs such as Adobe Acrobat and Zip have long been free."

Refutation: Predatory pricing is only illegal for a monopoly. Antitrust laws promote competition, which fosters innovation and lowers prices. If a business gives something away for free, but it has no potential of achieving a monopoly and recouping its costs later on, then the business is not guilty of predatory pricing, since recoupment is a necessary element of predatory pricing. Free items are good for the consumer as long as it doesn't lead to a monopoly, that can charge much higher prices later on. If a business attempts predatory pricing in the hopes of greater future profits, but fails, then that's good for the consumer, and better prices is one objective of the antitrust laws.

Argument: Monopoly means "One choice", not ten choices.

Refutation: A monopoly is simply a business that has pricing power, which Microsoft clearly has. It has such complete control of the market that the competition doesn't matter, no matter how much competition there seems to be.

Argument: People chose Microsoft products.

Refutation: Did they? For years, you couldn't buy a computer that didn't have a Microsoft operating system on it, EVEN IF YOU REQUESTED IT. So where was the choice? Ditto for other Microsoft software, such as MS Office. Sure, many people choose it today, because Microsoft has already established its monopoly, and because of the network effect (discussed above), competitors have little chance of selling their software. The other reason why people and businesses choose Microsoft is because they recognize what's plainly obvious, that Microsoft is a monopoly, and since it is, then what is the future of its competitors? How long will competitors be able to support their products if they aren't getting any money?

Argument: A product is worth whatever someone is willing to pay for it.

Refutation: A competitive market allocates resources best and provides the lowest prices for consumers. A product may be worth what one is willing to pay for it, but does one want to pay that price if they could pay a lower price? Everyone, without exception, would rather pay the lower price, not the highest price that they'd be willing to pay. The difference between what one is willing to pay and what one actually pays is referred to by economists as consumer surplus. Microsoft's high prices greatly reduce consumer surplus. To illustrate, consider gasoline. If the major oil companies conspired to raise prices for gasoline, most people would pay those prices, because their lifestyle is dependent on the car, and, needless to say, a car without gasoline is useless. But do these people actually want to pay the higher prices? Of course not. Or suppose General Motors were the only car manufacturer. GM would be able to charge far more for its cars than it can now, and most people would pay the higher price, because a car is more valuable to most people than what GM currently charges. So why doesn't GM charge the higher price? Competition. GM is not the only car manufacturer and its competitors have real market power, so, unlike Microsoft, it's not free to set prices. Therefore, people can buy cars for less money than they'd be willing to pay a monopolist, thereby enjoying a greater consumer surplus. Isn't this the better situation for consumers? There have been several articles published comparing revenues and profits for GM and Microsoft, showing that Microsoft's ratio of profits to revenue is much higher than GM's. This results because Microsoft is free to set prices at the profit-maximizing level, whereas GM is not, because GM has real competition. The fact that Microsoft is making such great profits is prima facie evidence that Microsoft is a monopoly.

Argument: What about Microsoft quality?

Refutation: Let's face it, DOS sucked, and Microsoft did little to improve it for more than 10 years. So did early versions of Windows. For instance, computers with Intel's 386 chip—a true 32-bit processor that could address up to 4 gigabytes of memory—became available in 1986, yet Microsoft only released a true 32-bit operating system—Windows NT—in 1993 for businesses, and consumers had to wait even longer, until 1995, when Microsoft provided Windows 95, that took advantage of the power and efficiency of the 32-bit chip. Even current versions of Windows can only be described as adequate. Microsoft rarely produced the best software in the beginning. I can't think of one example. Sure, Microsoft produces some pretty good products today. After all, when you design the operating system, the foundation of all other software, and you have billions of dollars of monopoly money for development, I guess at some point, you should be able to surpass your competitors, especially when your competitors aren't getting any money because you're a monopoly. Netscape is a great example of this. There's no question that early versions of Netscape were much better than early versions of IE. But Netscape couldn't make any money, because Microsoft was giving away IE for free. So how can Netscape afford to improve its product? On the other hand, Microsoft has billions of dollars it got by charging high prices for its monopoly products, so it can afford to spend huge sums of money developing IE and still not charge for it separately. Is this fair competition? What's surprising is how long Microsoft took to surpass its competition, and in some cases, this is questionable. Even though Microsoft gets far more revenue for MS Office than Corel gets as a company, the WordPerfect Office suite is still comparable to MS Office. There is hardly anything you can do in MS Office that you can't do in WordPerfect Office even today.

Argument: The AOL-Netscape merger will give Microsoft more competition.

Refutation: While it is true that AOL-Netscape will probably give Microsoft more competition in the browser market and certainly as a portal, this really won't affect Microsoft's monopoly. Microsoft isn't charging for IE separately, and Microsoft doesn't have a monopoly in Internet portals. AOL certainly isn't going to compete against Microsoft with office suites, operating systems, and programming tools, and AOL certainly isn't going to be able to force Microsoft to reduce prices in these monopoly products. Thus, the competition here is not significant.

Some have argued that Microsoft's distribution of IE for free was not predatory pricing because of potential profits from advertising and e-commerce. While both Microsoft and Netscape recognized this recently, they certainly didn't consider these sources of revenue during the beginning of the browser wars. There is ample evidence, some of which I presented above, that Microsoft specifically used predatory pricing to bankrupt Netscape, that this was, indeed, Microsoft's intent. Note Bill Gate's quote in the Financial Times: "Our business model works even if all Internet software is free. We are still selling operating systems. What does Netscape’s businessmodel look like? Not very good." Microsoft wants to be the standard setter on the Internet, and it can't do this if it has real competition. And, of course, this answers another current argument, that most people choose IE because it is superior. Yes, that's true now, but it certainly wasn't true through the first 3 versions of the browsers. With Netscape deprived of money for research and development by Microsoft's anticompetitive tactics, and Microsoft spending billions of dollars of monopoly money, why is it surprising that IE is now better than Netscape? While Microsoft's predatory pricing of IE didn't bankrupt Netscape, as Microsoft clearly wanted, it certainly weakened it considerably.

It is also argued that Microsoft will not be supreme in the future because everything is moving to the Internet and away from the desktop. While the Internet will certainly assume greater importance, it will not obsolete the desktop; it will not deprive Microsoft of its monopoly profits, at least for the foreseeable future. While it is true that Microsoft's dominance will eventually come to an end — such is the fate of all monopolies — does that mean that we should let Microsoft to continue to bilk consumers out of billions of dollars in the meantime?

Of course, one can advance many other arguments for or against Microsoft. But none of these arguments can really obscure the fact that Microsoft is a monopoly that has competed unfairly, and charges exorbitant prices for its monopoly products.

Microsoft Remedies

Because the Software Industry is a Natural Monopoly Industry, a Software Monopoly is Inevitable. Thus, Microsoft Should Not be Broken Up.

One of the main remedies in the Final Judgment (original source: http://www.usdoj.gov/atr/cases/f4900/4909.htm, no longer available) is to break Microsoft up into two companies. A good reason why Microsoft should not be broken up is because a software monopoly is inevitable.

The average unit cost of software continually declines with increased output. This means that software companies have great incentive to continually lower prices, so that they can expand their output and lower their costs. This, in turn, would lead to more sales for the companies, allowing them to lower prices further. Eventually, a victor will emerge, and it will be a true monopoly. Pure competition in a natural monopoly industry will always lead to a monopoly.

While Microsoft could be forced to eliminate all artificial barriers to competition, the courts will not be able to eliminate or even reduce the natural barriers to competition in the software business. Thus, Microsoft's dominance, or that of any spin-offs, is assured.

Microsoft achieved this monopoly through anticompetitive means, which allowed it to maintain high prices, and it's clear that Microsoft's monopoly will only expand. But breaking Microsoft into two companies, one with the operating systems, and the other with the rest of the applications, including Office, will only create two monopolies instead of one, and much more importantly, it won't force the companies to reduce prices.

However, the conduct remedies in the final judgment are certainly reasonable and necessary. They include:

Microsoft will be prevented from punishing any OEM that supports competing products.

Microsoft will be forced to license Windows on equal terms and equitable prices, and both terms and prices will be published on a public website.

OEMs will be free to configure Windows for their customers. (Microsoft argues that this violates their copyright rights. But think about it. If Microsoft had true competition, competitors would gladly allow the OEMs to configure the software, so that their operating system gets distributed and not their competitors'. Microsoft has no real competitors, therefore it is free to dictate.)

Microsoft shall not change Windows code that will have a deleterious effect on other software unless such code changes are communicated to any affected parties in advance. (Although this seems a little vague, I believe what is being said here, is that, if Microsoft changes any code, such as APIs, that current software depends on, then those changes should be communicated to the other software companies. This is only fair, because if Microsoft Windows programmers changed some APIs, for instance, then they would have to communicate those changes to other Microsoft programmers so that other Microsoft software continues to work properly. So it would only be fair to also communicate those changes to competitors; otherwise, Microsoft can simply disable competing software by changing the underlying code, thus giving its own software an unfair advantage.)

Equal terms and access must be given to all ISVs and IHVs regardless of whether they support Microsoft software or competing software.

No exclusive dealing or contractual tying.

Microsoft shall not bind middleware products to any OS unless it provides a way to remove the middleware from the operating system by end users or OEMs. If OEMs remove the middleware, then the price of Windows charged to OEMs must be reduced by the ratio of the byte size of the middleware as a separate product to the applicable version of Windows.

No agreements limiting competition.

Microsoft shall continue licensing prior versions of Windows at the same or lower price as that product was sold initially.

Stay

An order that suspends the enforcement of a judgment or some aspect of it, preserving the status quo, for a certain length of time, in order to accomplish something related to the case, usually an appeal. It does not invalidate the judgment.

Even the most ardent supporter of Microsoft could not disagree with these remedies, because they're fair. But Microsoft doesn't want to play fair. It was seeking to stay all of the above conduct remedies in its appeal, but Judge Jackson has sent the case directly to the Supreme Court, and stayed all remedies until completion of the appeals (original source: http://www.microsoft.com/presspass/trial/appeals/06-13dojstay.asp, no longer available). Unfortunately, even if these conduct remedies would have taken effect, it would not end Microsoft's monopoly because it is already well established, and thus, the natural barriers to competition will remain. These simple remedies would have been far more effective in 1990 while there was still some effective competition. Nonetheless, these conduct remedies would certainly help competitors.

I would add at least two more requirements. (1) Microsoft should be forced to reduce prices to average total costs, which would include a normal profit, and the prices should continually decline as sales volumes rise, as would happen under true competition. The main reason why Microsoft can add IE to Windows without raising prices is because it is already charging so much for Windows (relative to its costs). This would be the greatest benefit to consumers.

(2) OEMs should be required to itemize Microsoft software so the public can see what software they are being charged for, and to give the consumer a choice as to whether they want it or not, especially if they are paying for it. As long as the OEMs continue to distribute Microsoft software, other companies have little chance and little incentive to compete against Microsoft. Remember, it's the other companies that do most of the important innovation. The most important paradigms in computer technology originated with other companies—the Internet, browsers, email, spreadsheets, word processors, the mouse, graphical user interface, handwriting recognition, instant messaging, voice interaction, HTML, XML—even most aspects of the operating system were copied from Unix, and especially Apple, as well as from shareware and utilities that were constantly being developed to make up for the deficiencies of Microsoft operating systems. And needless to say, most of its other products, including Office, incorporate ideas largely derived from competitors' products. Here's an interesting quote from one of the DOJ's Remedies document collection (original source: http://www.usdoj.gov/atr/cases/f4600/4643.htm, no longer available), 1st footnote at the bottom of the document, referring to Microsoft's assimilation of other people's ideas:

According to one Microsoft insider, this has been the pattern at the company: "and let's face facts. Innovation has never been Microsoft's strong suite. we're much better at ripping off our competitors. For example, we did not invent either ASP [active server pages] or IE, we bought them!" RX8

Microsoft was rarely the first in anything. For all the billions that Microsoft claims to invest in research and development, it has little to show for it.

This is why competition is important. It not only lowers prices to near marginal cost, but provides greater utility and responsiveness to the market. A monopolist has much less incentive to satisfy the needs of the market, because there is no competition to impel it. There is no question in my mind that Internet Explorer is a much better product because Netscape was giving it stiff competition, and hopefully, with the new release of Netscape 6 imminent, this will continue. And it is highly unlikely that IE would have been free, at least in the beginning, if Microsoft wasn't so desperate to monopolize Internet software. (In fact, Internet software was part of the Plus! pack before Microsoft decided to make an all-out effort to monopolize the browser market.) After all, Microsoft is charging us for almost everything else. Only in those market areas where it wants to monopolize does Microsoft give software away for free, or has its software distributed by OEMs. This, of course, is the basis of predatory pricing, and it has worked well for Microsoft.

No question, the public does benefit by having a standard in software, and Microsoft's anticompetitive practices did accomplish this sooner than it would have under true competition. The advantages of software standards and software's nil marginal cost makes Microsoft a natural monopoly, and thus, it should be forced to reduce prices on those products which are unlikely to be dislodged by competition—notably Windows, MS Office, and Visual Studio, Microsoft's programming tools. Microsoft should be free to develop new products, but it shouldn't be allowed to use anticompetitive means to win market share. These conduct remedies would also minimize a major concern of the DOJ, that of regulating Microsoft. There would be little need for it.

Microsoft Has Effectively Won the Antitrust Lawsuit

Yes, technically, Microsoft lost the trial at the district level. Even so, Microsoft has, in effect, won. Why? The Supreme Court has sent the case back to the Court of Appeals. Now the case could easily drag on for years, and thus, during that time, Microsoft will be free to gouge the public of billions of dollars and to stifle competition. Even if Microsoft eventually loses completely, the loss would be moot, because, by then, Microsoft would have made its fortune from its software monopoly and will have moved on to other things, which it is doing even now, because the software upgrade business is only going to last so long at such lucrative levels. Time and the glacially slow legal process are definitely on Microsoft's side. The longer Microsoft can extend the litigation, the better for it.

Some people argue that, just for this reason, the antitrust laws can't deal effectively with high-tech companies, because the industry changes too fast. However, it is not antitrust laws per se that cannot deal with the pace of change, it's the legal system itself, with its grotesquely inefficient adversarial system that allows lawyers to argue ad infinitum, ad nauseam, and ad absurdum about even the most obvious facts.

I think the DOJ's approach to the current antitrust trial is feeble. They should have focused on Microsoft's conduct in general, its use of anti-competitive methods—especially OEM distribution—and its exorbitant prices rather than focusing specifically on the browser wars. Microsoft's monopoly is much broader than that. If the DOJ had focused on the exorbitant prices that Microsoft charges, they not only would have had more concrete evidence of Microsoft's monopoly power, but they would have had much more public support. By understanding that the software business is a natural monopoly business, and understanding the natural barriers to software competition, it becomes easy to see what Microsoft has done, and what it is doing.

Conclusion

Microsoft has been very successful in bamboozling the public. After all, once a monopoly has been achieved, less money is needed for advertising its products, and more money is needed for public relations, aimed at convincing people that it's not a monopoly. Such money has been used for direct advertising, and indirect public relations tactics, such as paying conservative groups to publish papers supporting Microsoft as if they were independent opinions, lobbying Congress, and asking the government to limit the funds available for antitrust actions. Microsoft's tactics have been very successful. Many a forum poster has argued endlessly about things they know nothing about, convinced, in spite of the glaring evidence to the contrary, that Microsoft is not a monopoly. Indeed, Microsoft is regularly listed in the top 3 of the most admired companies in America, even as it steals billions from the very people who admire it. Now that's great marketing!

It is now apparent that Microsoft, with its new version of Microsoft Office, Office XP, is continuing its tradition of charging hundreds of dollars for small improvements. (Original source: http://www.zdnet.com/products/stories/reviews/0,4161,2708939,00.html, no longer available.)

Microsoft wants to try a new tactic for extending the upgrade cycle, and to generate more sales and revenues—selling software by subscription. Although Microsoft has not released the details of its subscription model, Microsoft will probably continue its tradition of giving the least value for the money. In fact, with subscriptions, Microsoft may even be able to raise prices without people realizing it, because it will be more difficult to evaluate the price-value ratio. Other good reasons Microsoft wants to sell subscriptions is that it lowers the initial investment for the consumer, thereby making it more affordable (although not a better value), and making software purchases more of an impulse buy, with less consumer evaluation as to whether the software is worth it or not. In fact, you, the potential consumer, will not be able to evaluate the worth of software subscriptions because you can't know what you are getting for your money, or whether you need what you are getting. Even the computer magazines that regularly evaluate software upgrades will not be able to make recommendations except on the initial upgrade.

Microsoft intends to test market the perpetual license fee. Maybe this is what Microsoft is really talking about when it talks about software subscriptions. Microsoft wants users to pay periodic fees, probably annually, for as long as they use Microsoft's software. Yes, you bought it, but it still is Microsoft's software. You merely bought a license to use it. Up till now, you were entitled to use the software indefinitely without paying any more money, but Microsoft knows that upgrade sales are coming to an end, so, to keep the copious milk coming out of the cash cow, it wants to change the license agreement. Microsoft wants you to pay it perpetually for as long as you use their software. Presumably, they will even add a little value for your money, just as they have always done, and I do emphasize a little. Or maybe not. You'll still have to pay Microsoft anyway!

Why does Microsoft think it can get away with this outrageous scheme? Here's an interesting quote from the Yahoo article reporting the new licensing model: "Microsoft is also negotiating from a position of strength." (i.e., has monopoly power) "I don't think there are any customers today who have the option to walk away from Windows and Office. It's as entrenched on the desktop as it ever has been.''

I would have to say these quotes are absolutely true. All of those years of OEM distribution are really paying big dividends, but isn't that the goal of predatory pricing, to sell cheap or give away software for the opportunity to raise prices far above competitive levels later, and not only that, but to collect those revenues for ETERNITY! Wow! And so many people think Microsoft isn't a monopoly!

I don't think Microsoft's new licensing scheme is going to work. It will just outrage too many people. If the very hallmark of a monopoly is pricing power, would this not be the ultimate proof that Microsoft is a monopoly!

If Microsoft is split, it will continue to be a great stock investment, since neither company will be required to lower its software prices, and therefore, as the user base expands, profits will only increase for both companies—at the expense of the consumer.

While many people bemoan what is happening to Microsoft today, it is the direct result of Microsoft's anticompetitive behavior. Microsoft could have succeeded as a legal monopoly. A monopoly isn't illegal per se. It's the use of anticompetitive methods of establishing and maintaining a monopoly that are illegal. If Microsoft simply used its advantages to develop the best software, then Microsoft could have just let the market decide. They would have attained their monopoly legally, and there would have been no antitrust violations, no antitrust trials, or consent decrees. But, as clearly shown above, Microsoft didn't do this, because it would have taken longer for Microsoft to establish its monopoly, it would have been forced to improve the software faster, thereby adding much more value to each upgrade, causing the upgrade cycle to end more quickly for more people (since they'll have what they want), and it would have been forced to reduce prices as it competed fairly against other companies, which Microsoft wanted to avoid, and did.

I constantly read in forums and magazine articles talking about Microsoft's great success and profitability. I can understand why some magazines support Microsoft, since Microsoft is one of the biggest advertisers on the Internet, but it baffles me why so many people never consider where all of these profits are coming from. They're coming from you. You're paying hundreds of dollars for software that could easily be $30 or less. And this, in my opinion, is where Microsoft hurts the most.